Italy's Bank Funeral Shows EU Still Using Crisis Playbook

(Bloomberg) -- A decade has passed since the start of the financial crisis, but when it comes to handling struggling banks, the European Union still hasn’t moved on.

Italy’s taxpayer-funded wind-down of Banca Popolare di Vicenza SpA and Veneto Banca SpA highlighted the patchwork of EU and national laws and guidelines that govern the funneling of public money to banks, despite years of work on a common rule book intended to end the era of big bailouts.

In allowing Italy to pour as much as 17 billion euros ($19.4 billion) into liquidating the two banks, the European Commission relied on its guidance that state aid for banks is justified “as long as the crisis situation persists, creating genuinely exceptional circumstances where financial stability at large is at risk.” The 2013 document, which replaced guidance from five years earlier, hasn’t been updated, meaning that as far as the EU is concerned, the crisis rages on and taxpayers can foot the bill when banks collapse.

“In the world of bank regulation there are still two parallel universes: one where bank bailouts are frowned upon as an abuse of taxpayers’ money, and another where bank bailouts are considered as a politically more expedient and cheaper way of solving banking crises,” said Christian Stiefmueller, a senior policy analyst at the independent watchdog Finance Watch in Brussels. “These two sets of rules are not compatible.”

‘Little Clarity’

The EU laid down new bank-failure rules in 2014, after member states used almost 2 trillion euros to prop up lenders during the crisis. The Bank Recovery and Resolution Directive foresees small banks going insolvent like non-financial companies. Big ones that could cause mayhem would be restructured and recapitalized under a separate procedure called resolution, in which losses are borne by owners and creditors, including senior bondholders if necessary.

Italy succeeded in keeping Banca Popolare di Vicenza and Veneto Banca out of resolution, allowing it to shield senior creditors, when the Single Resolution Board said it wasn’t warranted because of the banks’ small size. That meant Italian authorities were free to dispose of the lenders under national insolvency law, which varies widely across the 28-nation bloc.

The confusion has prompted concern and calls for reform. “One might ask, why is national insolvency law more favorable for the owners and creditors than if the resolution is done according to the rules of the European resolution authority,” German Finance Minister Wolfgang Schaeuble said on June 28.

Bank of Italy Deputy Director General Fabio Panetta said EU rules on bank failure should be improved to make the process of state intervention more effective, according to a report in Il Messaggero.

EU and Italian authorities say they followed the rules in approving the plan. A number of key decisions were made to give Italy control of the banks’ liquidation, starting with the SRB’s conclusion that resolution under BRRD was “not warranted in the public interest.”

Public Interest

Under EU law, the resolution objectives that determine public interest include avoiding “significant adverse effects on financial stability.” The SRB said neither of the Italian banks “provides critical functions,” so their failure wouldn’t have ripple effects in the markets.

Once Italy got its hands on the banks, however, it insisted that public money was needed to grease the liquidation deal whereby Intesa Sanpaolo SpA took over their good assets for one euro and will also receive about 5 billion euros from the state to maintain its capital ratios.

The European Commission, which approved Italy’s plan, explained that while the winding up of smaller banks “may not affect the European financial system, their market exit may still have effects in the regions where such banks are most active.” The notion of regional fallout doesn’t figure in the laws the SRB used to make its determination; instead, the commission pointed to its 2013 guidance on state aid.

“This is where the fudge was,” said Federico Santi, an analyst at Eurasia Group. It’s hard to argue that liquidation under national law that spared senior creditors was the best way to meet the SRB’s legal objective to protect public funds, he said. The “political imperative” was to “prevent the backlash that bailing in senior creditors would have generated.”

‘Question Mark’

The SRB’s first resolution case, Spain’s Banco Popular Espanol SA, also involved a sale to a larger competitor that left senior creditors unscathed. Elke Koenig, the head of the SRB, suggested on Monday that without a takeover by Banco Santander SA, the situation could have become much more complicated.

“We were very lucky because in this case there was a bank that could be sold and a buyer,” Koenig said at a panel discussion in Frankfurt. Without it, there would have been “a major question mark” over Banco Popular, she said.

Intesa’s takeover of the two Veneto banks will make it the leading banking group in Italy’s northeast, one of the country’s wealthiest regions. Yet the commission said the public money plowed into the deal didn’t constitute state aid to Intesa because it “was selected after an open, fair and transparent sales process, fully managed by Italian authorities, ensuring that the activities were sold at the best offer available.”

In other words, other potential buyers wanted an even sweeter deal. The “open and unconditional competitive tender” test is set out in the Banking Communication.

‘Serious Disturbance’

So what is the Banking Communication that underpinned approval of the Italian plan? As the commission said in announcing its decision, these are “temporary crisis rules” based on a provision in EU basic law that allows state aid to “remedy a serious disturbance in the economy of a member state.”

In the Banking Communication, the European Commission said the treaty’s requirements “continue to be fulfilled.” It made this judgment in August 2013, not long after a 10 billion-euro bailout of Cyprus that involved closing the country’s second-largest bank, and has never revisited it.

In the document, the commission foresees the possibility of liquidation aid because ordinary insolvency might not be feasible “in the absence of mechanisms allowing for the resolution of credit institutions without threatening financial stability.” Yet the function of BRRD, which entered into force nearly a year and a half after the Banking Communication, is to provide such mechanisms.

‘Outrageous Circumvention’

The Banking Communication foresees a review by the commission “as deemed appropriate.” When asked if the commission planned this review in the near future, a spokesperson said only that EU state-aid rules are “temporary crisis rules.”

Sven Giegold, a German lawmaker in the European Parliament, said the case of Banca Popolare di Vicenza and Veneto Banca was an “outrageous circumvention of the rules.”

“In the absence of a financial crisis, there is no legal basis for the approval of the new banking subsidies by the European Commission,” he said. “Rather, this is a politically motivated decision, and one that will have negative consequences for the credibility of the banking union.”

--With assistance from Rainer Buergin and Steven Arons

To contact the reporters on this story: Alexander Weber in Brussels at aweber45@bloomberg.net, Boris Groendahl in Vienna at bgroendahl@bloomberg.net.

To contact the editors responsible for this story: Patrick Henry at phenry8@bloomberg.net, John Glover