Photographer: Marc Hill/Bloomberg

Monte Paschi Bailout Plan Has Some ECB Supervisors Grumbling

Updated on
  • Political consensus for rescue said to make dissent difficult
  • EU bank-failure law allows precautionary aid to viable lenders

When the European Central Bank declared Banca Monte dei Paschi di Siena SpA solvent last December, the first step toward a state-funded rescue, some members of the 19-nation Supervisory Board weren’t fully on board.

Confronted with what they saw as a political agreement to bail out the world’s oldest lender, dissenters went along with the consensus despite their concerns about the bank’s health, according to people familiar with the decision, who declined to be identified because the deliberations were private.

The ECB has kept a low profile in the three months since, ceding the spotlight to the European Commission in Brussels, which will rule on the Italian government’s eventual plan. But nothing has alleviated the misgivings of some Supervisory Board members about using taxpayers’ money to prop up Monte Paschi for a third time, the people said.

An ECB spokesperson declined to comment on the decision.

To make sense of the Monte Paschi debate, you have to start with a 2014 law known as the Bank Recovery and Resolution Directive, which sets out the EU’s bank-failure rules. The law assumes that if a firm needs “extraordinary public financial support,” this indicates that it’s failing and should be wound down. In that process, investors including senior bondholders can be forced to take losses.

Bad Loans

An exception, known as a precautionary recapitalization, is allowed for solvent banks if a long list of conditions is met. As the name suggests, this tool isn’t intended to clear up a bank’s existing problems, such as Monte Paschi’s mountain of soured loans. This temporary aid is allowed to address a capital shortfall identified in a stress test.

Daniele Nouy, head of the ECB Supervisory Board, reiterated in an interview on Monday that Monte Paschi and other Italian banks in line for a bailout are “not insolvent, otherwise we would not be talking about precautionary recapitalization.”

Not everyone is convinced the bank, whose woes date back many years, qualifies for this special treatment.

“It is unclear if Monte Paschi meets the BRRD’s exemption criteria, and their use has the appearance of promoting national political concerns over a stricter reading of the newly established European rules,” said Simon Ainsworth, a senior vice president at Moody’s Investors Service. “The plan could risk damaging the credibility of the resolution framework, especially given that it would mark its first major test case.”

Stress Test

The ECB’s decision on Monte Paschi’s solvency and capital gap was announced by the lender the day after Christmas. The ECB published an explanation of the precautionary recapitalization process a day later, but said little else publicly. On Dec. 29, the Bank of Italy issued a statement that broke down the 8.8 billion-euro rescue into its parts.

Solvency in the case of a precautionary recapitalization is determined based on two criteria, the ECB said: the bank meets its legal minimum capital requirements, and it has no shortfall in the baseline scenario of the relevant stress test. 

Monte Paschi passed both tests; in the baseline scenario, based on the European Commission’s economic forecasts, its common equity Tier 1 ratio, a key measure of financial strength, actually rose to 12.2 percent of risk-weighted assets from a starting point of 12.1 percent. By the end of 2016, its CET1 ratio had dropped to 8 percent.

Retail Investors

In the view of some ECB Supervisory Board members, while Monte Paschi cleared the hurdles for aid, its viability was bolstered by unrealistic valuations of its bad loan portfolio, the people said. The board gave the all-clear even though the possibility that Monte Paschi sold junior bonds inappropriately to retail investors wasn’t fully reflected in the solvency assessment, they said.

Asked last week if the ECB was under pressure to go easy on struggling banks, Nouy said, “Absolutely not.” The decision to declare a bank failing or likely to fail is a “delicate one,” and while some lenders in the euro area are in “troubled waters,” they can’t be sent into resolution so long as they meet the solvency criteria in European law, she said.

Rome’s political resolve also made it hard for supervisors to object, the people said. The complex decision process needed to put an EU bank into resolution requires so many sign-offs by national and EU agencies that it’s unrealistic to force it upon a country as powerful as Italy if the government has other ideas, they said.

State Aid

Since the solvency decision was made, the ECB has stayed out of public discussions of Monte Paschi, emphasizing consistently that the European Commission, the EU’s executive arm, is in charge of determining if Italy’s bailout request qualifies for the exemptions in BRRD and if it squares with state-aid rules.

Nouy also made a point of saying that that EU law contains a fail-safe should a supervisor hesitate to pull the resolution trigger when this step is warranted: the Single Resolution Board in Brussels also has this power. But currently, “at least two European institutions think that we’re not there yet,” she said.

The ECB’s role now is to provide data and expertise to the commission as it assesses Italy’s plan for restructuring Monte Paschi, recapitalizing it and restoring it to stability. The Supervisory Board will also have to sign off on the plan for restructuring Monte Paschi and restoring it to health, the people said.

Some lawmakers say the only long-term solution to the issues raised by the Monte Paschi case is to get rid of the precautionary recapitalization tool altogether.

As Belgian lawmaker Philippe Lamberts said to Nouy in the European Parliament last week: “To avoid all of the controversy we find ourselves immersed in today, wouldn’t it have been preferable -- and I won’t conceal that this was our preference -- not to include in the law the possibility of a precautionary recapitalization?”

— With assistance by Sonia Sirletti

(Adds Nouy comment in 17th paragraph.)
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