Bank of Italy Seen Vigilant as Monte Paschi Risk Surfaced

The Bank of Italy acted vigilantly in its oversight of Banca Monte dei Paschi di Siena SpA, with the discovery of accounting irregularities leading to a criminal investigation targeting previous management, a former senior Bank of Italy official who was involved in the inspections said.

Pressure from the central bank prompted a shakeup of executives at the Siena-based lender last year and led to the uncovering in January of secret documents about some transactions hidden from regulators, said the person, who asked not to be identified because the probe is confidential.

The central bank is rejecting criticism that lax oversight allowed Monte Paschi, the world’s oldest bank, to amass risky positions that may saddle the company with hundreds of millions of euros in losses and already have necessitated a 3.9 billion-euro ($5.3 billion) bailout request. The Monte Paschi affair came to light after Bloomberg News reported on Jan. 17 the lender engaged in a transaction with Deutsche Bank AG in 2008 that obscured losses.

The Bank of Italy, then headed by Mario Draghi, first became concerned about Monte Paschi’s finances when it reviewed a 2008 bank takeover. That led to two full inspections of Monte Paschi starting in 2010. The central bank became so concerned about the irregularities it notified prosecutors in March 2012, according to a report dated Jan. 28. Draghi, 65, was named president of the European Central Bank in 2011.

Hide Losses

The documents revealed this month show that Monte Paschi’s former management used structured-finance deals to hide losses from previous operations. The bank has said it was investigating three transactions and will release a report by the middle of this month on their financial impacts.

Monte Paschi’s former management obstructed the efforts of the central bank’s inspectors to determine the true nature and risks of the transactions, the person said.

After an inspection in 2010, the Bank of Italy demanded a daily report on the company’s liquidity balance because the deals were absorbing funds and then insisted that Chief Executive Officer Antonio Vigni personally sign the reports.

As part of a further inspection, started in September 2011, the central bank met with senior management in November of that year and demanded “they assume their responsibilities,” according to a summary of the bank’s actions obtained by Bloomberg.

Removed Vigni

Monte Paschi’s board removed Vigni two months later and the central bank then challenged the executive’s 4 million-euro exit package. The Bank of Italy, now headed by Governor Ignazio Visco, turned over its finding from the inspection in March to prosecutors. Chairman Giuseppe Mussari left a month later when his mandate expired.

Shareholders didn’t find out about the irregularities until this month, though it wasn’t the central bank’s responsibility to make their concerns public. The Bank of Italy’s mandate is to ensure sound management and solid finances at the nation’s lenders, the person said. Market regulator Consob could have ordered Monte Paschi to inform shareholders, though when there is a criminal investigation, prosecutors often ask Consob not to make the case public, the person said.

Downgrade Risk

Moody’s Investors Service placed Monte Paschi debt on review for a downgrade yesterday because of “considerable uncertainty” over the impact of the structured finance deals.

Monte Paschi shares rose 2.4 percent to 24.8 cents at 9:21 a.m. in Milan, after sliding 9.5 percent yesterday.

Some politicians have slammed the central bank. Italian Senator Elio Lannutti, who also heads Adusbef, a consumer group for bank customers, called on prosecutors to extend their criminal investigation to include the oversight by the Bank of Italy and market regulator Consob.

“Those who had the duty to verify the correctness and veracity of the counts of Monte Paschi, including the hedging operations with derivatives, namely the Bank of Italy and Consob, didn’t do their job,” he said in a Jan. 23 statement.

Far from skirting its responsibility, the Bank of Italy is responsible for exposing the irregularities, which it first discovered while reviewing the lender’s unrelated 9 billion-euro purchase of Banca Antonveneta SpA, completed in 2008, the former central bank official said.

That takeover and losses stemming from a 25 billion-euro position in government bonds as part of the structured deals eroded the bank’s finances as the European debt crisis decimated the value of those assets. Monte Paschi was forced to seek two government bailouts to meet European Banking Authority capital requirements.

European Regulator

The revelations about Monte Paschi have come as Draghi prepares for the ECB to take the lead in creating a European-wide bank regulator. German newspapers have pointed the spotlight at the fact that the irregularities happened while he was running the Italian central bank.

The Frankfurter Allgemeine Zeitung published an article on Jan. 29 with the headline ‘Monte dei Paschi Affair Reaches ECB President Draghi.” Die Welt yesterday ran a story under the headline ‘Bank Scandal Puts Draghi Under Pressure.”

Support in Germany, the home of the ECB, is crucial for Draghi as he tries to push the euro region out of a debt crisis that has forced five of 17 members to seek bailouts. His pledge last year to buy potentially unlimited quantities of government bonds was criticized by Bundesbank President Jens Weidmann even though it has staunched the three-year crisis for now.

‘Continuous and Thorough’

The Italian government, for its part, has rejected criticism of the central bank. Regulatory oversight of Monte Paschi was “continuous and thorough” and the bank remains solid even with a capital shortfall and possible losses linked to structured deals, Finance Minister Vittorio Grilli said in parliament on Jan. 29.

“With hindsight everything becomes so black and white, so we must think there was complacency, said Giovanni Ferri, an economics professor at Luiss University in Rome, who previously worked at the Bank of Italy and the World Bank. “But I doubt that is fair. You need the insiders to help you out with targeting where you want to excavate to find something wrong.”

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