Why Deutsche Bank's Monte Paschi Scandal Still Matters

(Bloomberg Opinion) -- On Friday, judges in Milan convicted executives from the world’s oldest bank, Banca Monte dei Paschi di Siena SpA, for falsifying its accounts in collusion with Deutsche Bank AG and Nomura Holdings Inc. Some 11 years after the misdeeds, it’s hard to have complete faith in the ability of regulators to prevent similar bad behavior.

That executives have been held accountable for one of Europe’s biggest banking scandals will be some comfort to savers and taxpayers. Deutsche and Nomura face financial penalties of $175 million (Paschi has already settled). Michele Faissola, Sadeq Sayeed and Giuseppe Mussari — formerly of Deutsche, Nomura and Paschi — were among 13 executives sentenced to jail, the most senior bankers convicted of crisis-era chicanery. Nomura is considering an appeal, while Deutsche will review the court’s ruling.

Regulators don’t have much to take credit for here in reining in the excesses of these lenders. After hiding hundreds of millions of dollars in losses in 2008 and 2009, Paschi went on to build a mountain of bad loans that led to multiple taxpayer rescues. Deutsche, meanwhile, has only just embarked on a serious plan to restore profitability after myriad fines for dubious practices.

The complex Deutsche derivatives trade at the center of the Milan trial was certainly ingenious. Dubbed Santorini, it made a loss disappear on a previous deal that would have blown a big hole in Paschi’s 2008 results. To do this, Deutsche made one bet on interest rates with Paschi that it would almost certainly lose and another wager that it would win. While Deutsche paid out immediately on the bet that Paschi won, the German bank let the Italian bank pay out on the wager that it lost over several years. That allowed Paschi to window-dress its accounts and hide the previous loss.

The outside world would be none the wiser for years, until I came across documents that helped recreate the concoction. Within days of my article being published in January 2013, a similar deal emerged between Paschi and Nomura; Paschi said it would restate its accounts. The derivative dressed up as a loan was so successful for Deutsche it repeated the trade with clients around the world. The German bank also ended up correcting its figures.

Given the widespread nature of the gimmickry, it’s reasonable to ask where the regulators were in all this. The simple answer: asleep at the wheel. For years (and well before my reporting) financial supervisors from New York to Rome were aware of how far these banks were pushing the envelope.

As early as 2010, Italy’s central bank, then headed by former European Central Bank president Mario Draghi, had discovered that Paschi had been masking losses. The Bank of Italy said in a 2010 report that it didn’t have “powers as regards accounting” and that the matter needed further study.

There was no great rush. The same Paschi managers remained in place through 2012. In the meantime, the bank’s bad loans were piling up as local political interference and reckless lending led it to overlook credit risk. Bailout followed bailout as losses mounted.

As recently as 2016, Paschi was probably insolvent and its financial controls were still deemed perilously weak. That didn’t stop the ECB in 2017 nodding through the lender’s third helping of state aid in less than a decade. Over and over, supervisors failed to pick up on practices detrimental to Paschi’s longer-term viability.

Deutsche’s rehabilitation has been torturous too. It wasn’t until 2015, well after the bank had been embroiled in multiple scandals — from rigging benchmarks to laundering dirty Russian money — that regulators sought to tame its risk-taking ethos. Under former chief executive officers Anshu Jain and his predecessor Josef Ackermann, Deutsche Bank had become a factory of risky and complex trades from its London hub as it sought to compete head on with Wall Street. 

Only now, under chief executive officer Christian Sewing, is the German giant attempting a deep reboot of the business by shrinking its trading unit. Unfortunately the ambitious reorganization has coincided with an economic slump.

Of course, there are many obstacles that regulators will point to that complicate their roles, not least the need to tread carefully to maintain financial stability — especially at a systemically critical lender such as Deutsche.

But by failing to place sufficient pressure at the right time, regulators have allowed the banks they oversee to delay the inevitable: These companies need to find other ways to make money. European bank valuations are close to the level they were in the 1980s; confidence in the industry is fragile.

There is some optimism that the shift of bank regulation from the national level to the European level, via the ECB, will strengthen supervision. The deepening of a euro zone banking union with a common deposit insurance scheme, championed last week by Germany’s finance minister Olaf Scholz, would further erode national meddling.

Unfortunately the ECB’s early record as a watchdog has been mixed. Draghi’s successor Christine Lagarde has pledged to keep banks safe. She also needs to keep them honest.

To contact the editor responsible for this story: James Boxell at jboxell@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Elisa Martinuzzi is a Bloomberg Opinion columnist covering finance. She is a former managing editor for European finance at Bloomberg News.

©2019 Bloomberg L.P.