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.

The European Central Bank looks like it's bending its own rules on the Banca Monte dei Paschi di Siena SpA bailout. That may not be such a bad thing.

By letting the Italian state take control of Monte Paschi, while still considering it solvent, it can avoid the much harsher terms required for non-solvent banks under the new Bank Recovery and Resolution Directive. Those would have potentially involved all bondholders and even depositors with more than 100,000 euros ($104,570) in the bank.

This is politically expedient for the new Gentiloni government, which needs to avoid a voter backlash from retail bondholders of subordinated Monte Paschi debt. Similarly, the ECB would like to resolve this quickly, ahead of its plan to get far tougher with the banks over non-performing loans in 2017. It wants to move the main offender under state protection and out of the firing line now.

Yet there's a clear contradiction in how it's going about this. While the ECB refers in its most recent press release to its July stress test of Monte Paschi, it also told us of Monte Paschi’s further liquidity drain of 4.4 billion euros in the three weeks to December 21st.

The situation has deteriorated so quickly that just through December, the float has reduced from 11 months to four. Things have probably got worse if Italy's latest Target2 liabilities of 359 billion euros are any guide. It's not easy to understand how Monte Paschi can be solvent under any normal criteria.

Stressful Times
The Italian bank system's reliance on external liquidity, as measured by Target2, has more than doubled since mid-2015
Source: Bloomberg Intelligence

Bundesbank president Jens Weidmann has said not to rush this bailout as it may not be sustainable -- a shot across the bows if ever there was one, along with an emailed statement this week from the German finance ministry about "no circumvention" of the rules. Is it any wonder German two-year bonds have gone to new record negative yields of minus 80 basis points?

Italian press reports speculate that the country's bailout fund might now provide 6.3 billion euros in aid, out of the 8.8 billion euros Monte Paschi needs to bolster its balance sheet. Last week, this was expected to be only 3 billion euros. The ECB has put it at 4.5 billion euros.

Taking all the retail subordinated bondholders out of the equation by raising their holdings to senior debt may solve a big political problem. But it's akin to a huge dose of state aid.

Still, there's good reason to solve this most complex of banking situations under the aegis of the state. It will allow the Italian government to control any shareholder meeting, as it will have an equity stake of more than 67 percent. That's important to avoid either a swift collapse of the bailout or a shareholder revolt, and to handling legal issues with institutional subordinated bondholders who will now bear a larger share of the bail-in burden.

And by the end of 2017 about half of Italian bank subordinated bonds held by domestic retail investors will have matured anyway, according to Jonathan Tyce of Bloomberg Intelligence. The main Monte Paschi bond owned by retail bondholders matures in 2018.

In fairness, the ECB's crisis management since the Renzi referendum has been pretty masterful. It's just this is another example of where a strict adherence to the ECB regulations won't work in the real world. Expediency doesn't allow for "one rule fits all," whatever the Germans might think.

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