Italy’s Newly Unelected Prime Minister, Mario Draghi, Has Urgent Unfinished Business With the World’s Oldest Bank

In his former role as governor of the Bank of Italy, Draghi was partly responsible for Monte dei Paschi’s di Siena’s decline. Now he must reverse it.  

Mario Draghi set a new precedent this week, becoming the first former ECB Chairman to head up a national government. And he did it without winning a single popular vote. The long-serving central banker and one-time managing director of Goldman Sachs International was handpicked by Italian president, Sergio Mattarella, to lead a so-called “government of experts”. Italy’s main political parties were by and large thrilled with the choice. So, too, unsurprisingly, were the markets. 

Unfinished Business with a Very Old Bank

Close to the top of Draghi’s agenda is urgent unfinished business with Italy’s third largest lender, Monte dei Pachi di Siena (MPS). At 549 years of age, MPS is the world’s oldest bank but it has seen better days. On Wednesday, it reported a worse-than-expected annual loss of €1.7 billion for 2020. This is a problem for the government since it owns 64% of MPS’ stock, after bailing out the lender with a €5.4 billion capital injection in 2017.

The Italian government has promised the European Commission that it will exit its positions by mid-2022. But it is struggling to find a buyer, for a slew of obvious reasons. The bank is still under-capitalized and will soon need another capital injection. It’s barely turned a profit in the past decade. Its books are still crammed full with toxic assets at varying stages of decomposition. It also faces an estimated €10 billion in legal claims.

The task of finding a suitable suitor will now fall to Draghi as prime minister, which is kind of ironic given that Draghi himself bears some of the responsibility for the bank’s demise.

Most of MPS’ problems began with its €9 billion acquisition of rival Italian lender Antonveneta from Banco Santander in 2007, just as the markets were peaking. The bank did little due diligence and overstretched its finances, paying 50% more than the €6.6 billion Santander had paid just months prior as part of its joint acquisition (with Royal Bank Scotland and Belgian bank Fortis) of Dutch giant ABN Amro. For MPS it was an ill-timed disaster, just as the purchase of ABM Amro’s disparate other parts had been for Royal Bank of Scotland and Fortis, both of which would also end up requiring taxpayer-funded bailouts to stay alive.

The director of the Bank of Italy’s office in Padova, A. Minnella, expressed serious misgivings about the acquisition. In a letter to the Bank of Italy’s head office in Rome Minella warned of significant “critical issues” in the bank’s technical profiles and competitive positioning, as well as “accentuated problems” that require immediate action by company managers. Antonveneta suffered from serious “financial imbalances” and its sustainability was “at risk,” he said. Yet the warnings were ignored at head office. Draghi signed off on the Antonveneta deal in early 2008.

When Bankers Actually Went to Jail

By 2010, it was becoming apparent that MPS was haemorrhaging cash. To try to conceal this fact, the bank had been using complex derivatives trades cooked up by the likes of Deutsche Bank, Nomura and JP Morgan Chase to hide the full scale of its losses, much as Greece had done with its sovereign debt. When those trades came to light, trials were held, from which it emerged that the Bank of Italy had known about one of these trades, dubbed Santorini, as early as 2010 and done nothing about it. 

In 2019, the strangest thing happened: 13 bankers — employees of MPS, Deutsche and Nomura — were sentenced to jail for of up to seven years. In 2020, lightening struck twice. Monte dei Paschi chairman Alessandro Profumo, former CEO Fabrizio Viola and former president of the supervisory board Carlo Salvadori were also sent down. 

Throughout this time Draghi himself was in Frankfurt driving interest rates in the Euro Area to heretofore unimaginable lows. As ECB President, he was ideally placed to (at the very least) clear the way for the European Commission to authorize the bailout of Monte dei Paschi in 2017. As Elisa Martinuzzi wrote in a 2019 column for Bloomberg News, the bailout was controversial:

By the time the ECB replaced the Bank of Italy as Monte Paschi’s chief supervisor, its bad loans were rising and it had already received another infusion of money from the state. Draghi was presumably well aware of Monte Paschi’s problems, yet he and the ECB later came to the bank’s rescue. He declined to be interviewed for this column.

After injecting 8 billion euros of their own money during 2014 and 2015, Monte Paschi’s shareholders balked at putting in yet more funds. By the end of 2016, the bank had no choice but to seek state aid for a third time just to stay afloat.

For Monte Paschi to qualify for government aid, it had to satisfy regulators that it was meeting minimum capital requirements and that no taxpayer money would be used to offset existing losses. Pulling that off would have been difficult, however. According to an internal ECB report I wrote about last month, the regulators’ own analysts thought Monte Paschi hadn’t adequately provisioned for loan losses. Its likely insolvency should have made it a candidate for liquidation.

Today, MPS is a shadow of its former self, kept alive by direct government support. But that support is scheduled to end fairly soon. The government had aimed to reach an agreement to reprivatise MPS by April. But it is keeping all of its rather limited options open:

• Plan A: Offload MPS to Unicredit. The only Italian lender that is big enough to absorb MPS and crazy enough to actually want to is Unicredit. UniCredit has had informal contacts with the Treasury about MPS since last summer. Its then-CEO Jean Paul Mustier wasn’t interested in a costly merger but he’s out of the picture now. His replacement is Andrea Orcel, a high-profile deal maker who, as luck would have it, advised MPS on its merger with Antonveneta. To make the deal more palatable, the government is considering shielding any future owner of MPS from at least some of its legal claims.
• Plan B: Find a foreign suitor. This is likely to be an altogether more difficult task. Of the few international banks that already have operations of any scale in Italy — BNP Paribas, Deutsche Bank and Credit Agricole — none appears to have shown any interest. In fact, according to S&P Global, the only foreign entity that has requested access to MPS’ books is U.S. private equity fund Apollo Global Management Inc.
• Plan C: Split up MPS into smaller pieces. Italian newspaper La Repubblica reported on an alternative plan that would see the creation of a smaller, leaner MPS that would be focused solely on the regions of Tuscany and Umbria where it would have 20% market share. Its NPLs would be taken on by Amco and Fintecna. This plan would have the added advantage of avoiding drastic cuts to personnel “while the rest of the branches in the Center and South would be sold to the best buyer”.

It’s an interesting concept, breaking up a bank into smaller pieces rather than merging it with another one. But it’s unlikely to sit well with Draghi, who, like many at the ECB, sees over-capacity as the biggest cause of weakness of Europe’s banking industry — not the zombifying giants at the very top of the financial food chain or the interest margin-destroying negative interest rates that Draghi himself unleashed. And Italy already has one of the highest number of banks in the EU.  

A Loyal Servant

At the head of the 67th government of the Italian Republic, Draghi is now supposed to serve the interests of roughly 60 million Italian people. But he is, first and foremost, a servant of the financial establishment — and a very loyal one at that! He is a senior member of the Group of 30, a secretive Washington-based club of corporate and central bankers. Its membership reads like a Who’s Who of global finance, including current and former central bankers. Many now work or worked in the past for some of the world’s biggest banks and financial corporations. 

While the group prides itself on being a well-intentioned forum for “deepen(ing) understanding of international economic and financial issues,” its abject lack of transparency makes it an ideal setting for the trading of insider information or favors. In 2018, European Ombudsman Emily O’Reilly recommended that Draghi relinquish his membership. Otherwise, the public may begin to think that “the ECB could be open to influence in the shaping of new regulatory practices.” The ECB declined the recommendation, arguing that G30 discussions helped it understand economic and financial developments.

As ECB president, Draghi did whatever it took to keep the Italian economy and its banks afloat. That included buying up colossal amounts of Italian government debt — hence his popularity among Italian politicians. At the same time, he demanded austerity from Italy’s policymakers. This accelerated the economy’s downward spiral, weakening Italy’s production capacity and crippling its growth potential. Instead of decreasing, Italy’s debt-to-GDP ratio surged as the economy shrank. 

Today, they say, Draghi is a different man. He wants to loosen, rather than tighten, the purse strings. In the words of Marche University economics professor, he is “in transition from Friedman to Keynes.” Only time will tell how true that is.