Draghi Bank of Italy Knew of Monte Paschi Missteps in ’10

The Bank of Italy under former Governor Mario Draghi spotted accounting irregularities that allowed Banca Monte dei Paschi di Siena SpA to mask losses more than two years before the lender was forced to say it will have to restate profit.

In 2010, “a problem came to light” on Monte Paschi’s booking of a structured deal called Santorini, Italy’s Rome-based central bank said in a report dated Jan. 28. The Bank of Italy alerted “other authorities” a year later and talks with those regulators, which it didn’t identify, haven’t concluded. It didn’t explain the delay in forcing the bank to disclose the information.

The Bank of Italy’s account of Monte Paschi’s use of derivatives, released yesterday, calls into question its oversight of the world’s oldest bank, which is seeking the second taxpayer bailout in four years. Bloomberg News revealed the Santorini deal in an article on Jan. 17. Monte Paschi borrowed about 1.5 billion euros ($2 billion) in December 2008 from Deutsche Bank AG as part of a derivative deal, dubbed Project Santorini, that helped it disguise losses. Hours after the Bloomberg report, Monte Paschi said it will conduct a “thorough” review of several structured deals to determine their effect on previous years’ accounts as well as any future impact.

‘Continuous’ Oversight

“I would have expected the Bank of Italy to have requested transparency from Monte Paschi back in 2010 after reviewing the transactions,” said Carlo Alberto Carnevale-Maffe, professor of business strategy at Milan’s Bocconi University. “Hidden documents found recently wouldn’t have changed the substance of the original findings.”

The Bank of Italy said that as early as 2010 it sought daily liquidity reports from the lender as margin calls on Santorini drained funds. The regulator said a week ago Monte Paschi hid documents, impeding its analysis of the “true nature” of the company’s dealings.

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 yesterday.

Monte Paschi fell as much as 6.8 percent in Milan trading and was down 5.9 percent to 25.2 cents at 1:45 p.m., giving the bank a market value of 2.94 billion euros.

Draghi Role

Draghi, 65, led the Bank of Italy from 2005 to 2011, when he left to succeed Jean-Claude Trichet, 70, at the helm of the European Central Bank. He has worked as an economics professor in Italy, a financial diplomat at the World Bank, a bureaucrat at his country’s Treasury and a banker at Goldman Sachs Group Inc. In December 2005, he was named to replace Italian central bank Governor Antonio Fazio, 76.

Officials for the Bank of Italy didn’t have an immediate comment. Asked about Draghi’s role in overseeing Monte Paschi, an ECB spokeswoman declined to comment.

Prosecutors in Trani, Italy, opened an investigation into the Bank of Italy and market watchdog Consob’s supervisory activity on Monte Paschi, consumer group Adusbef said in an e-mailed statement today. The investigation follows a complaint submitted by the lobby earlier this year.

Masking Loss

Santorini helped Monte Paschi obscure a 367 million-euro loss from an older derivative contract with Deutsche Bank, according to more than 70 pages of documents outlining the deal and obtained by Bloomberg News. As part of the arrangement, the Italian lender made a losing bet on the value of the country’s government bonds. The bank’s new management is still trying to determine the extent to which Santorini and two other derivative deals were used to distort earnings. Monte Paschi never disclosed the effect of the 2008 deal in its annual reports.

The bond bet was among transactions that drew the Bank of Italy’s scrutiny as early as 2009 as repo operations were “resulting in the absorption of high liquidity margins,” the regulator said in its Jan. 28 report.

The bank’s government bond holdings rose five-fold between 2009 and 2011 to more than 25 billion euros, resulting in deterioration in its capital level when the sovereign-debt crisis hit and Italy’s debt securities plunged. The bond losses and the strain of its 9 billion-euro purchase of Banca Antonveneta SpA in 2008 left the lender as the only major Italian bank to need a government bailout.

Hidden Documents

The central bank followed up with more probes in 2011 and 2012, though the 2010 “inspection did not reveal any information to support the launch of a sanctions procedure or an alerting of the legal authorities,” the central bank said.

Monte Paschi told the Bank of Italy in 2011 the structured deals were part of its “carry trade” strategies and weren’t submitted to its administrative body. Meantime, the U.S. Federal Reserve, Britain’s Financial Services Authority and Hong Kong’s regulator helped monitor the bank’s liquidity at its branches in New York, London and Hong Kong, the Bank of Italy’s report said.

Italy’s third-largest bank and prosecutors are now reviewing three money-losing derivative deals, Santorini, Alexandria and Nota Italia. The lender said it discovered in October that former managers signed a “mandate agreement” with Nomura Holdings Inc. to cover losses on a mortgage-backed derivative called Alexandria with new, riskier derivatives.

The hidden document, proving the link between the unprofitable Alexandria derivative with the new one, should have led the bank to book a loss of more than 200 million euros on the original transaction, instead of spreading it over the 30-year maturity of the new deal.

Not ‘Police’

Monte Paschi Chief Executive Officer Fabrizio Viola, who took the helm a year ago, said Jan. 28 the bank has been unable to find a similar mandate agreement for the Santorini financing.

Monte Paschi will complete the review of the losses, which haven’t been quantified yet, in the first half of February, and they will be included in the bank’s 2012 accounts, Viola said.

The Bank of Italy’s role isn’t to “police” Monte Paschi, the current governor, Ignazio Visco, 63, said Jan. 25 in an interview with Bloomberg Television in Davos, Switzerland.

The Bank of Italy “summoned the senior management of Monte Paschi” and of the foundation that is its biggest shareholder in November 2011 “to make them face up to their responsibilities and ask Paschi to quickly and definitively turn around the way it conducts its business,” the report said.

Monte Paschi risks further losses of as much as 500 million euros on a 2010 securitization of about 1.5 billion euros of real estate loans, dubbed “Chianti Classico,” weekly Panorama said today, citing documents that include minutes of board meetings from November and December of last year. The bank “forcefully denied” in an e-mailed statement that the deal would produce losses.

Criticizing Bailout

Paschi’s general director Antonio Vigni left in January 2012, after almost six years at the top job. Executive Chairman Giuseppe Mussari, 50, who led the bank since 2006, stepped down in April and last week resigned as chairman of Italy’s banking association.

Italian consumer association Codacons is seeking to block Monte Paschi’s bailout. The group said it will file a complaint in a Rome administrative court against the Cabinet, Economy Ministry, Italy’s central bank and market regulator Consob, seeking 3.9 billion euros in damages from the Bank of Italy for not adequately monitoring the bank’s activities.

Codacons’ request follows criticism about the central bank’s supervision raised by some politicians, including former Finance Minister Giulio Tremonti and another consumer group, Adusbef.

“New derivative accounting policies are needed in Europe to avoid similar situations in the future,” said Giuseppe Di Taranto, professor of financial history at Rome’s Luiss University. “There’s too much room for interpretation under current rules.”