After the last financial crisis, Italy’s banks appeared fairly healthy due to their relatively small exposure to subprime mortgages leading to the 2007 crash. However, under the surface problems were piling up. Also unlike Spain or Ireland, Italy did not use EU funds to support its banks. Now as troubles are mounting, the government in Rome is seeking to help the country’s weakest lenders but faces much stricter European laws regarding bank bail-outs, suggesting another banking crisis is imminent. These rules were designed to shield taxpayers from covering the losses of bank failures.
How Dire Is the Situation At Italy’s banks?
Already one year ago, in June 2016, non-performing loans were piling up at Italian banks, €360bn to be precise. That was a third of all such loans in the Euro-Area. And the situation hasn’t changed much since then. New research suggests that, as of March 2017, 114 out of almost 500 banks in Italy are in trouble. These banks all have so-called Texas-Ratios (TR) of 100% or more. The Texas-Ratio measures the fraction of a bank’s non-performing loans that is covered by the bank’s tangible common equity. Or to put it in the blunter terms of American money manager Steve Eisman:
“All the bad stuff divided by the money you have to pay for all the bad stuff.”
Hence, a ratio above 100% implies that the non-performing loans exceeds the bank’s equity. Or in other words: 114 of Italy’s banks do not have enough money to cover all the bad stuff.
The situation at Monte Dei Paschi di Siena – the oldest bank in the world – and two Venetian banks, Popolare di Vicenza and Veneto Banca, is particularly dire. The three banks have TRs of 269% (Monte Dei Paschi), 210% (Popolare di Vicenza) and 239% (Veneto Banca). However, Italy’s two largest banks do not look promising either. Unicredit and Intesa Sanpaolo both have TRs above 90%.
What Are Rome’s Plans?
The government in Rome is willing to bail out the country’s most troublesome banks. This month Rome already secured preliminary permission by European Commission to bail-out Monte Dei Paschi. The bank will receive fresh capital from the Italian government. Further, Monte Dei Paschi will have to sell its portfolio of non-performing loans under market conditions and various measures to increase the bank’s efficiency will be implemented. Among those, a limit for senior management compensation is required. Under the new measures, it cannot exceed ten times the average salary of the bank’s employees.
A similar plan might be difficult to implement for the two troubled Venetian banks. EU authorities requested Rome to find private investors to put up money to save the two banks. Italian law guarantees deposits up to €100,000 in case of a failure of the depositing bank. The depositor protection fund providing these guarantees is financed by the countries healthy lenders. Hence, Italy’s healthier banks seem willing to help Rome with its bail-out plans as this would avoid costly payments to depositor guarantee’s if EU regulators would shut down the two banks. Some of the healthy banks have already signed-up, but under the condition that more banks do so.
Spain as An Example?
Meanwhile, Spain sets an example for an alternative path, increasing pressure on Rome. Last Wednesday, the European Single Resolution Board announced that Banco Popular Español – Spain’s sixth-largest lender – will be shut down and sold for the symbolic price of €1 to its competitor Banco Santander.
The European Single Resolution Board (SRB) has only been operational since January 2015. Its mission is to: “[..] ensure an orderly resolution of failing banks with minimum impact on the real economy and the public finances of the participating Member States of the [European] Banking Union”. Banco Popular Español is the agency’s first real test and as it seems its first success.
Banco Santander was chosen as the buyer through an auction. SRB remains quiet, though, on whether there had been other bidders as well. Banco Popular’s outstanding shares, as well as its Contingent Convertible Bonds – or so-called CoCos – were amortised. Junior bonds had been transformed to shares and were sold for €1 to Santander. Holders of senior bonds remain unaffected. Thus, the bank’s investors must bear the costs of the bank’s failure instead of the taxpayers. At the same time, the Banco Popular’s customers have continued access to their accounts and their savings remain untouched. Also, bond markets responded calmly to the news, indicating the risk of contagion is perceived low.
A Possible Roadmap For Italy
This all increases the pressure on Italy’s government to allow for a similar solution for Popolare di Vicenza and Veneto Banca. After all, maybe dissolving the two banks is indeed a better path than stumbling from one bailout to the next. After all both banks required bailouts before. Some consolidation in the Italian banking sector seems inevitable given the country’s vast number of banks that are in trouble. Repairing Italy’s banks arguably will be a longer process. But by resolving the most troubled banks – always one at a time from the most important or urgent cases to the least important ones – could yield a chance to restore market forces and the Spanish example shows that it is possible without causing havoc to the markets. Investors could not count on governments anymore to jump-in with tax money soaking up losses. Instead, investors would need to put pressure on bank’s managers to prop up efficiency and risk management.