Bail-out in Italy
The first severe violation of the Single Resolution Mechanism?
At the beginning of 2016, the newly set up Single Resolution Board took office – as the main authority of the Single Resolution Mechanism (“SRM”), which was created to prevent future bail-outs of banks as far as possible.
At the end of 2016, Italy adopted a large scale bail-out program, tailored – but not limited – to Tuscan Banca Monte dei Paschi di Siena (“MPS”).
How does it fit together what happened at the beginning and what happened at the end of 2016? Has the bail-in principle been abolished shortly after its introduction or is there an exception from the ban of bail-outs for this very case?
According to the European directive 2014/59/EU („BRRD“) distressed banks are to be rescued through measures that do not primarily consist of state support; instead primarily the owners and creditors are meant to carry the burden of the rescue, i.e. bear losses (“bail-in”). Other than in bail-out procedures the taxpayer shall not be the one anymore who is to pay for failing banks. At the same time, it is the aim to reduce the danger of states getting into financial difficulties due to their rescue endeavors for banks. As a consequence of the financial crisis of 2007/2008 state aid shall only be applied as an ultima ratio, if and when all other means of rescue have been applied without success.
With a view to the high proportion of non- and sub-performing loans on the balance sheets of Italian Banks, the activation of the SRM came at a very unfortunate point in time in Italy. Not only once the Italian Government tried to weaken the rules of the SRM, to temporarily suspend them or to establish exceptions for certain cases – without success.
The ECB requested MPS, the most problematic of the Italian banks, to raise new capital from private investors. The bank focused on a mix of new stakes, debt-to-equity swaps and a sale of non-performing loans. And, surprisingly to some, it did not look utterly unpromising at times. But, despite intense efforts, no anchor could be convinced to join and in late autumn the first signs of investors closing their books for 2016 could be noticed. The referendum in Italy and the subsequent resignation of the Italian Prime Minister brought the recapitalization to a total halt. Italy tried to convince the ECB of an extension of the deadline due to the new and special political situation – but it was denied: the ECB did not see any room for a postponement.
Based on the calculation of the ECB MPS has a capital gap of well above EUR 8 bn (EUR 5 bn based on calculations of MPS). The bail-in principle, if applied, would lead to the creditors and shareholders having to pay for the rescue of MPS; only if this fails state aid could be allowed. Relatively unusual, and hence problematic, is the fact that MPS has a large number of retail investors, holding subordinated bank bonds.
At the end of December 2016 it became public that no bail-in is planned for MPS. Instead Italy will set up a state backed rescue fund with a volume of EUR 20 bn. It is designed to help MPS and other Italian banks. As a first step, the European Commission swiftly approved a temporary liquidity support for MPS granted by the Italian state in December 2016. A recapitalization by the Italian state shall follow as a second step. The relevant authorities will presumably decide upon the approval of this second step within the next months.
By this, despite the primacy of a bail-in according to the SRM, Italy aims for a state aid bail-out of distressed banks.
Nevertheless, it is planned to structure the bailout in compliance with BRRD and SRM. For that purpose Article 32 sec. 4 undersec. 1 lit. d BRRD shall be used. It contains a kind of exemption clause, which allows state aid instead of a bail-in under certain conditions. Pursuant to this clause, extraordinary public financial support instead of a resolution is allowed if it is necessary to remedy a serious disturbance in the economy of a Member State and preserve financial stability. In particular, an injection of own funds or purchase of capital instruments at prices and on terms that do not confer an advantage upon the institution can be admissible as long as the bank is, at its core, solvent and viable. This concept is usually referred to as “precautionary recapitalization“.
This exception and its application to MPS et al. is heavily criticized by parts of the public – as expected. “In this way the EU-Commission creates a precedent to which banks will refer in the future when it appears to be expedient” is heard; or “In this way the SRM runs the risk of being seriously undermined right at its outset.”
And indeed, at first glance, it is not completely obvious in this case whether or not all preconditions of the exemption clause are met. A “serious disturbance in the economy” and to “preserve financial stability”, for example, indeed require interpretation, but might be more obviously met with regard to other banks and situations. Furthermore, the question of the bank being solvent at its core is not easy to answer, in particular considering the capital gap and the difficulties of organizing a private sector recapitalization.
Politically charged is the fact that many of the creditors and owners are retail investors. This shows the political dimension of the SRM, which should not be underrated. Should retail investors really bear losses in the case of a failing bank?
It is not the aim of this article to judge whether Article 32 sec. 4 undersec. 1 lit. d BRRD is an appropriate provision or whether the preconditions of a precautionary recapitalization are met in the case of MPS. The latter will be investigated in the next months. But what the discussion around MPS and other Italian banks already impressively shows, is that the opinion, that the highest risk for the SRM is of political nature rather than operational, is truly worth discussing. Furthermore in 2013, when the idea and the first preparatory measures of the SRM got off the ground, the institutions of the EU were not questioned to the extent they are today. It should not astonish that this has substantial influence on the current discussion in consideration of the far reaching consequences of a bail-in. On the other hand, no one should be surprised about the concerns that, in the end, not much of the bail-in principle will be left.