Over the Christmas holiday, while hopefully no one was watching, the Italian government organized a ‘bail-in’ of the country’s third largest bank, Monte dei Paschi (MPS), which stood on the edge of insolvency and illiquidity. There are three things you need to know about this deal:
1. It is not a bail-in, it is a taxpayer-funded bail-out/nationalization.
2. The amount of the bail-out might have been enough a year ago but not now.
3. MPS is the tip of a huge iceberg likely to take down the entire Italian banking system.
A bail-in is when an insolvent bank’s shareholders, subordinated debt holders and depositors share the cost of recapitalizing or re-organizing the bank. That’s what the E.U. rules require. Italy stepped around the rules to avoid panicking lenders and depositors of other banks. But I think they will panic anyway.
As the Financial Times (FT) writes, the Italian government is set to take a 50% to 70% stake in MPS, up from its current 4% stake, as part of the government’s third bail-out of the bank in as many years. The FT notes that the government rescue, which has long been resisted, is designed to contain “the slow-burn crisis in Italian banking that has alarmed investors and become the main source of concern for European financial regulators.” I doubt containment is possible. And we still have to see if Germany, long a critic of state bail-outs, will agree.
At first glance, the MPS rescue, announced on December 23, appears to be an application of European bail-in rules. The bank was unable to raise the €5 billion it needed to meet a capital shortfall revealed by recent stress tests. This triggered a “precautionary recapitalisation” under article 32 of the new Banking Recovery and Resolution Directive, requiring more than €4 billion of subordinated debt in MPS to convert to equity.
But the Italian government ‘bail-in’ did not stop there. The bank can then swap those new shares held by retail investors for a new bond, this time a senior-ranking one with little default risk. That swap would create a problem for MPS, which cannot handle more debt. So, the government will instead buy these securities from the retail creditors. Technically, the government is not bailing out the bank because it is buying from individual investors. It is not yet known if the subordinated debt holders will get 100% of their face value but I’m betting they do. Otherwise, the political backlash and the financial turmoil would be explosive. So much for the rules.
Oh, and by the way…
While this bail-out was being concocted, the ECB re-calculated the capital it believes MPS needs. Surprise! The ECB determined that the bank’s liquidity position had rapidly deteriorated between the end of November and December 21 as depositors yanked even more billions from the bank, a perfectly reasonable course of action in light of concerns about the bank’s viability. The new amount needed immediately is €8.8 billion, up 76% from the original €5 billion in less than a month.
That’s the price of waiting, dear reader. The problems do not go away. They get bigger.
MPS suffered €14 billion of deposit outflows in the nine months from January to September this year, 11 per cent of its total deposits as shown below.
Will this nationalization stem the bank run at MPS or other Italian banks? I think not. People are not stupid. More deposits are leaving and more bailouts are coming. The Italian government approved a €20 billion addition to the country’s debt ceiling to take care of bank bail-outs. This is ridiculously low compared to the estimated €360 billion in non-performing debt in the Italian banking system.
But €20 billion may be too much for Germany. One of the big concerns associated with Italy’s banking rescue is that it will worsen the country’s fiscal outlook at a time when it already has one of the highest ratios of debt to gross domestic product in Europe, at 133 per cent. The €20 billion amounts to about 1.2 per cent of GDP, making it highly unlikely that Italy can meet its commitments on managing its debt under E.U. budget rules.
Italian officials insist that the banking rescue is a temporary “one-time” effort which will not impact the key fiscal measures used by the E.U. LOL, dear reader, LOL. We have been following the European banking issues for more than a year. In my opinion, they could bring down the world’s financial system in the coming year. Do you own gold?