Italy Rattles Europe’s Post-Crisis Banking Doctrine
(Bloomberg Opinion) -- The European Union takes great pride in the steps it has taken since the financial crisis to limit the danger that taxpayers will have to bail out troubled banks again. But two new laws in Italy risk making a mockery of this rulebook, opening the way for a new season of unchecked state aid.
Italy’s populist administration has set up a 1.6 billion euro ($1.8 billion) fund to compensate investors who have lost their money in a string of recent bank liquidations. This will pay junior bondholders up to 95 percent of the original value of the investment and shareholders up to 30 percent. The arrangement is almost exclusively for retail investors.
While the exact details of the plan still need to be rolled out, the criteria to obtain compensation appear very lax — the ruling Five Star and League parties seem determined to help as many investors as possible. Consob, Italy’s securities regulator, has been excluded from the process, getting rid of an independent check on the acceptance standards.
Rome has also said it is ready to inject taxpayer money into beleaguered Banca Carige SpA. This does not entail an immediate intervention, as the lender is still in a last-ditch effort to raise fresh capital from the private sector. But were this attempt to fail, the government would intervene via a so-called precautionary recapitalization.
These two ideas have one thing in common: They put taxpayers on the hook for banking losses.
In the first case, private investors would be compensated for bets which have gone awry. Compensation doesn’t seem to require a showing of misselling or regulatory failure, and this clashes violently with the principle that investors should face both sides of a trade. Compensating retail shareholders and not institutional junior bondholders introduces a worrying arbitrariness in the hierarchy of creditors. And paying back equity investors creates a dangerous precedent for the future — anyone who buys banking stock now will expect that the state will come to the rescue if they are wiped out.
The lifeline that the government might throw to Carige suffers from a similar problem. The Genoa-based lender is too small to be considered systemically important, and so doesn’t meet the EU test for allowing a precautionary recapitalization. Were the European Commission to let Rome inject public money anyway, it would lower the bar dramatically for banks to benefit from state intervention.
The European Commission faces a dilemma: If Brussels blocks the Italian government and lets the bank fail or demands a more restrictive approach, it risks being criticized for hitting retail investors against the will of an elected government. But if it rubber-stamps what the government has passed, it would deal a crushing blow to whatever is left of the laws governing the euro-zone banking union.
The precedents are not encouraging. In June 2017, the Single Resolution Board (the agency in charge of winding down large banks) and the European Commission allowed the controversial liquidation of two Italian banks. This string of decisions ended up granting a generous subsidy to Intesa Sanpaolo so that it could rescue parts of these two lenders’ business and, crucially, to honor in full senior bondholders.
The decision has created a dangerous precedent in the way banks now take over rivals in trouble. It is better to wait until they go to the wall, so that there is a chance the government might put together a generous dowry to encourage willing buyers. This set of distorted incentives may be already at play in the case of Carige: It makes more sense for the other banks to wait for what happens than to put in their bids now.
From Greece to Germany, the euro zone has no shortage of wobbly lenders regulators could soon have to deal with. Italy’s two-fold tests will show the commitment of the European Commission to enforce not just the letter of its new laws but also their spirit. What happens in Rome will definitely not just stay in Rome.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Ferdinando Giugliano writes columns and editorials on European economics for Bloomberg Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.
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