Finance

Marcus Ashworth is a Bloomberg Gadfly columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

Nationalizing your biggest bank is never a happy affair but, if you have to, do it quickly.

Ukraine moved swiftly last weekend -- alongside the International Monetary Fund -- to clean up its banking system by taking over Privatbank, securing a stable deal for depositors and preventing systemic risk.

There was a $5.5 billion capital shortfall to be filled, a big hole for such a fragile economy with only $15 billion in central bank reserves. Privatbank accounts for half of payments in Ukraine's banking system and one-fifth of its banking assets. Deposits exceed $8 billion, of which three-quarters are retail and they're clearly the priority here.

The European Union and Italy should take note as they struggle with a last-gasp solution for Banca Monte dei Paschi di Siena SpA. A crucial element is persuading retail holders of junior debt that they should swap it for equity. That would cut the amount Monte Paschi has to raise from a parallel stock offering -- the hardest part of its 5 billion euro ($5.2 billion) fund-raising plan. It needs the capital to defray 30 billion euros in non-performing loans, thereby allowing the world's oldest bank to battle on.

Retail Bond that Paschi needs to be swapped to Equity
Upper Tier II issued in 2008 for 2.16 billion euros holds the key to survival
Source: Bloomberg

The EU's rules over state involvement in bank bailouts, the Bank Recovery and Resolution Directive (BRRD), have created an almost impossible situation where all the involved parties are stumbling to get out of each other's way, and the state cannot act alone. But, as usual, how you handle the debt-holders is the key.

By contrast, Ukraine has been able to move decisively by bailing in the private bond and equity owners. It will bail in the three Privatbank senior eurobonds, which comprise slightly more than 5 percent of liabilities at $555 million. There is a lingering fear that these bonds could then be converted into equity, thereby wiping out the holders, although international creditors are unlikely to take that lying down, according to Oksana Reinhardt of MINT Partners.

Look Out Below
Privatbank's benchmark 2018 $ eurobond votes with its feet
Source: Bloomberg

Ukraine will need to be cautious about treating international holders of senior debt in the same way as Privatbank's former owners, who received 97 percent of its corporate loans and owned many of the bonds. The country plans to tap international bond markets in about a year's time, so needs to keep some goodwill.

Despite the need for Ukraine to iron out some last wrinkles, it still offers a model of sorts for Europe. The EU also wants to see bank rescues conducted by making sure the private sector shares the risk. 

In fairness, Italy's biggest problem revolves around protecting domestic retail bond investors, so the situations are different. If Monte Paschi doesn't succeed this week with its debt-for-equity swap, then a state rescue of at least 15 billion euros is waiting.

That still wouldn't provide the decisive action taken by Ukraine, and will involve a messy compensation deal for retail junior debt holders -- who should never have been offered this stuff in the first place. It's all incredibly confusing as different parts of the rescue plan hang on each other, dramatically increasing the risk of failure. 

Of course, if Italian press reports prove valid that Qatar, China and the Italian Post Office are prepared to step in with capital, then it may just succeed. But it really didn't need to be this difficult. The post-crisis EU regime on preventing state interventions has proved as damaging as the illness.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Marcus Ashworth in London at mashworth4@bloomberg.net

To contact the editor responsible for this story:
James Boxell at jboxell@bloomberg.net