Behind the Potemkin Village of EU Bank Regulation
The liquidation of two small banks has left Italian taxpayers on the hook for up to 17 billion euros ($19.3 billion) and raised doubts over the credibility of the euro zone banking union. The question of whether it could have been avoided is not just academic.
This decision, which saw Intesa Sanpaolo scoop up the good assets of rivals Banca Popolare di Vicenza and Veneto Banca for 1 euro, and taxpayers to subsidize the deal, has many midwives: the European Central Bank, the European Commission, the Single Resolution Board and the Italian authorities. While all of these bodies stress that the decision was taken according to existing rules, there are questions for each of them over their actions. The overall impression is one of a Potemkin village in EU banking regulation, where formal respect of the law hides a dangerous precedent.
The main questions are undoubtedly for the Italian government and the Bank of Italy, which agonized for at least 15 months over how to deal with the two banks. Their objective was to avoid "bailing in" bondholders as they feared this could cause contagion across the financial system. The authorities were also aware of possible political repercussions of a bail in, given the high number of retail investors who were sold the securities with little idea of the risk they were taking on.
The fear of having to impose losses on bondholders became real last year when the banks failed to attract any interest from investors after supervisors demanded they raise capital. Italy then created a private rescue fund, called Atlante, which took over the two banks at a cost of 3.5 billion euros.
However, this rescue was not sufficient to stop the bleeding of deposits and the depletion of capital. When it became clear this year that the banks would have to raise new capital, Italy opted for a "precautionary recapitalization." This would have meant wiping out shareholders, bailing in junior bondholders and providing an injection of public capital in order to protect the banks against future shocks. However, even this solution failed once the European Commission said Italy must find an additional 1.2 billion euros in private capital to cover pre-existing losses. Since it was impossible to find new investors, this left the government with few options to avoid a disorderly bankruptcy.
There is little doubt that the solution orchestrated last weekend by the government has the merit of avoiding financial panic. But Finance Minister Pier Carlo Padoan is wrong in saying there were no other options. Italy could have opted to resolve the banks 15 months ago instead of setting up Atlante. Some junior bondholders would have been hit -- as they were at the weekend -- and a bail in may have affected senior bondholders too, but the cost to the taxpayer would likely have been much lower.
The ECB must also share some of the blame. Its Single Supervisory Mechanism ruled that the two banks were "failing or likely to fail" on Friday. However, for months the SSM had said that the two lenders were solvent. There is a reasonable suspicion that it decided to play along with the dithering of the Italian government, instead of being a detached enforcer of the rules. This delay compounded the cost of the bank failure and dented the credibility of the SSM.
The European Union's SRB was also far too lenient. The board was set up in 2015 as part of the banking union to remove national governments and central banks from the politically sensitive decision to unwind a bank. On Friday night, the SRB ruled that the two banks were not systemic, opening the door to liquidation to take place under national law. This allowed Italy to spare senior bondholders, who would have certainly been hit had the SRB stepped in.
The two banks only have assets of 28 billion and 35 billion euros, providing some cover for the SRB's decision not to get involved. However, one of the reasons the two banks are so small is that they shrank following a year of crisis. Had the ECB and the SRB intervened before, resolution could well have been an option. The SRB will also have to face accusations that it kowtowed to political pressures. This casts a shadow over the credibility of one of the euro zone's newest institutions.
Finally, the European Commission has some explaining to do about its decision to allow Italy to grant state aid to Intesa Sanpaolo. Intesa was given a generous package, even though it only bought the "good" assets, leaving the risk from the toxic loan books to the Italian government. This included 1.3 billion euros to deal with the restructuring of the two banks; 3.5 billion euros to keep its capital ratio unchanged in spite of the acquisition; and an initial guarantee of 400 million euros on potential liabilities, including a package of loans worth up to 4 billion euros which Intesa fears could turn sour over the next three years.
The commission ruled that state aid was lawful because there was an open and transparent process to acquire the two banks. It added that this package was necessary to cushion the impact from the exit of the two lenders on the regional economy. However, there will remain questions over how truly fair and transparent this process was, given that it occurred under severe time pressure.
It is also hard to dismiss the differences between this case and the recent acquisition of Banco Popular, a troubled Spanish lender, by rival Banco Santander, where the bank had to find financing for the deal itself. Finally, one wonders whether the commission should have asked that the Italian government take a stake in Intesa, rather than simply handing out a grant, so that taxpayers could enjoy some of the future gains the bank will make.
Of course, there are reasons to feel positive about this rescue. Provided the decree is approved in parliament and there are no successful legal challenges in the future, Italy has cleaned up two very problematic banks, strengthening the resilience of its financial system. However, the troubles at the two Veneto banks should have been handled sooner, sparing many unpalatable choices which had to be made last weekend. This is no way to handle a long-simmering banking crisis.
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Therese Raphael at email@example.com