As readers may recall, Italy has been trying with no success to get the ECB and European banking authorities to allow it to rescue its banks. Unlike banks in most other European countries, Italy’s got sick the old fashioned way: by lending to businesses in its own market, and then having the loans go bad, in large measure to how lousy the post-crisis economy has been.
New Euronzone-wide banking rules took effect in January. They require bank bail-ins as the remedy for sick banks, with only narrow exceptions. “Bail-in” means wiping out shareholders, and then wiping out bondholders and converting bondholders to equity holders to the degree that you now have a bank with a decent equity cushion.
That might sound sensible, except in Italy, many banks defrauded depositors by persuading them to buy bonds that are junior enough to put them first in line in a bail-in, by telling them those bonds were just as good as deposits. So bail-ins would hurt and potentially wipe out a lot of retail savers. That would not only damage the economy in a serious way, but it would also create political havoc. Premier Matteo Renzi is already at risk of losing to Beppe Grillo’s Five Star movement in elections this fall. Bail-ins would seal his fate. Five Star has vowed a referendum on exiting the Eurozone. Given that the currency union has become an economic hairshirt for Italy, a referendum is seen as having good odds of passing
One would think the foregoing would motivate the Eurocrats to cut Italy some slack, and Renzi has made several cases as to why Italy should get a waiver. Commentators at the Financial Times are sympathetic. From an article last week:
Wriggle room was an issue much debated by investors in Europe’s banks this week: can Italy use as much as €40bn of public money to help its banks when the aim, if not the fine print, of EU rules is that it should not?
The question is pressing because Monte dei Paschi di Siena, the world’s oldest bank, may fall short when regulators this month assess its ability to withstand losses. Estimates for how much capital is needed range from €3bn to €6bn, after finding a buyer for perhaps €20bn of loans gone bad..
A cascade of problems could follow from the knock to confidence in the Italian financial system. The prospect of merging strong banks with weaker ones could fade. Retail investors, who the International Monetary Fund estimates own a third of the €600bn of bonds issued by Italy’s banks, may panic at the prospect of losses.
Yet the authorities have ignored Renzi’s pleas. But has the European Court of Justice given Italy a reprieve? From Reuters (hat tip Richard Smith):
European Union member states are not obliged to make shareholders and junior creditors pay before intervening to rescue a bank, the EU top court said on Tuesday.
EU rules imposing losses on bank creditors before a bank bailout were considered legal by the Luxembourg-based European Court of Justice in its ruling over a Slovenian banking rescue.
However, the rules are not binding on member states, the court said in its ruling that slightly limits the European Commission’s antitrust powers amid talks for an Italian banking bailout. The court said that burden-sharing by shareholders and subordinated debt holders was not a precondition for granting state aid to a troubled lender.
I need to turn in and have yet to see commentary elsewhere. Please provide links in comments if you do. Thanks!
Update: It looks at if Reuters, which was out first with the story, got it wrong. From Marc Chandler (hat tip Michael S):
The European Court of Justice upheld the principle of making creditors bear the burden for investment in banks that sour before government funds can be used. Italian banks are particularly sensitive to the ruling, which cannot be appealed because the European Banking Authority and European Central Bank stress tests on July 29 are expected to show that some Italian banks are under-capitalized.
One of my colleagues, an attorney who regularly reads ECJ and similar rulings, says they are much more difficult to parse than US decisions. Not only are they usually written in a more convoluted manner, but the ruling is seldom in English, and the official translations to English are often not very good. So she didn’t find the Reuters muff to be all that surprising.