Bail in or Bargain-bin for Italian Banks?

A journey into the Italian banking discount store

[The resolution of the Veneto banks was carried out using the Italian liquidation procedure, allowing greater scope to ensure the protection of bondholders. But the issues raised by bail‑ins remain. If banks are sold for one euro and there are more and more public incentives for the sale, is that truly a bail-in?]


A new banking communism?

The “resolution-solution” applied to the Veneto banks makes it official: based on the latest transactions, the average price of a bank in Italy is one euro. The umpteenth “bank rescue” decree that sets up the sale of Banca Popolare di Vicenza and Veneto Banca to Intesa Sanpaolo at the price of one euro officially establishes the existence of a discount store for Italian banks.

Incurable optimists might celebrate the creation of a discount market in banks, whereby any citizen can realise their dream of becoming a banker. Why not, since even people living on the poverty line[1] could buy hundreds of banks with their limited income? Such a cheap price ought to lead Istat to add “a bank” to the basket used to calculate the consumer price index.

On the other hand, considering that there are 522 banks in Italy (of which 393 do not belong to groups), as many people could use just one euro of their income to treat themselves to a “personal bank”. In doing so, Italy would boast the most democratic financial system in the world: popular ownership would give rise to an unprecedented system of crowdfunded banking, to the point that even the “Banker to the Poor” Muhammad Yunus would pale in comparison. It is often said that Italy is a country of armchair football coaches; now, we would become a country of amateur bankers. The die is cast.


The facts as they stand

Is that truly the case, or does something not quite add up? Let’s try to unravel this by looking back at the essential features of the various bank rescues of recent months. Three cases have a lot to teach us – for better or worse. On May 10th, the sale of three banks to UBI Banca was finalised (Nuova Banca delle Marche, Nuova Banca dell’Etruria e del Lazio, and Nuova Cassa di Risparmio di Chieti); in March 2017, the contract was signed for the sale of Nuova Carife to BPER Banca; and on 25 June, Banca Popolare di Vicenza and Veneto Banca were sold to Intesa Sanpaolo.

What do these transactions have in common? Easy: a) compliance with EU lawmakers’ desire to limit – and subordinate – state intervention in favour of contributions from private investors (“bail-in”); b) the approach taken, which is to separate the crisis-struck bank into two banks – one with the good-quality assets (“good bank”) and one holding all the non-performing loans (“bad bank”), while pursuing different but interconnected solutions for both entities; c) fulfilment of the acquiring banks’ need to limit investment by maximising the medium-term returns on the acquisition, above all achieved by using the notional price of one euro for the sale of the good bank, and pledging public funds to facilitate the sale of the good bank, on the one hand, and the disposal of the NPLs on the bad bank’s balance sheet, on the other.


The chain of misdeeds

As far as the first aspect is concerned, it is now clear that state intervention has been subordinated, but certainly not limited. The delay in finding solutions, and the uncertainty on categorising the individual rescues, has certainly not helped with the rationalisation of public intervention. It seems clear that “subordinating” and “limiting” the use of public funds has, in practice, been found to have contradictory goals.

Using the twin banks scheme – the Cains and Abels of finance – appears compromised by a number of false truths that news outlets take for granted: (i) it is not a new model, because it has been used in the past and (ii) it is not a model that represents, per se, the solution. Separating the deteriorated assets into a Cain bank – the “bad bank” – does not mean writing off the assets in question, which, by contrast, continue to show signs of life and to produce effects in terms of destruction or creation of value. The facts have shown that it is not enough to create an ad hoc vehicle if it’s not useful – and above all feasible. Strategies must be put into place to manage the poor-quality assets without fuelling an unfair distribution of wealth (more specifically, to the advantage of highly active operators in the NPLs market and to the disadvantage of junior bondholders).

The banks buying the “Abel banks” – or “good banks” – may well have objective reasons for discounting the purchase price: the acquisition implies additional capital requirements imposed by supervisory authorities and costs deriving from the management of the network, staff and the inherited assets. However, two facts conflict with the adoption of the notional price of one euro. First: even ordinary acquisitions carry immediate costs and managerial difficulties, alongside prospective benefits in the medium term. Yet, as a rule, these are not set at notional prices—at least not such derisory ones. Second, the deals to sell troubled banks in recent months have only related to the “good portion” of the banks being sold – hence they are comparable to some of the best value ordinary acquisitions – and, furthermore, have always been backed up by the State, both to protect risks arising from the assets sold and to cover costs including those pertaining to “social shock absorbers” connected to rationalising redundancies. So, if the sale relates to the “good bank” and the deals involve various forms of public support, why is there such a brutal discount on the price? Is a healthy bank really worth one euro? Even avoiding attaching any value to the assets of a good bank and the possible synergies arising from the concentration, is a banking licence alone truly worth one euro?

Collateral damage

Clearly, the answer to these—and other questions—will not be found in a technical appraisal, but can be traced in the complex political-institutional-relational framework that has built up around the resolution of banking crises in Europe.

The case-by-case approach adopted by the European authorities in interpreting and applying the new legislation on bank resolutions has created grey areas in the intersections between counterparties: specifically, between EU authorities and national governments, and also between governments and private investors.

In relations between the European Commission, the competent authorities and national governments, there is uncertainty over where to place individual transactions. In the case of the first “bank rescue decree” adopted by the Italian Government, the European Commission’s decision to consider the intervention of the Italian Interbank Deposit Protection Fund as a form of state aid, hindered the traditional “Italian way” of solving crises, requiring the solution to be contextualised against the EU Bank Recovery and Resolution Directive (BRRD). In the recent case involving the Veneto banks, the Single Resolution Board declared that, even though the banks were failing or likely to fail, they did not meet the criteria for the activation of the European resolution process, so the issue can be managed according to Italian insolvency procedures. That will be hard to understand for the junior bondholders of the first banks placed into resolution, which was made subject to the BRRD even before it had fully entered into force.

The adoption of the new resolution rules is also gradually concentrating bargaining power in the hands of a few, large banking groups. The urgent need to find fast, effective solutions contrasts with the need to ensure that public intervention complies with the rules on state aid. In this scenario, if governments are forced to seek rapid rescue by private investors, then the rescuers have to be large banking groups, as they are the only ones able to intervene without serious effects on their level of capital. Regardless of the adoption of EU or domestic resolution mechanisms, this situation does not help the position of governments – and hopefully, depositors – compared to investors, weakening their bargaining power at the negotiating table.


The Intesa-Veneto banks deal

With this in mind, it is easy to deduce that in the specific case of the acquisition by Intesa Sanpaolo, the contribution that Intesa had to make to the Atlante Fund for past, ongoing and potentially future rescues had a significant role in determining the sale price of one euro. Equally, it is easy to imagine that the €5.3 billion loan granted by Intesa to the Veneto bad banks – yielding 1% and guaranteed by the State – had an equally significant role. If the private sector is called into play, it plays by its own rules, which are well-known, predictable understandable (by their outlook), and inevitably tied to a quid-pro-quo approach. If, on the one hand, they have to contribute to the rescue, on the other hand, they will seek returns on the investment by cutting costs and reducing exposure to risk. That is how we should see the roughly 3.5 billion in public funds requested and obtained by Intesa to cover the additional capital requirements deriving from the acquisition, the approximately 1.2 billion public contribution to cover restructuring costs, and the public guarantees of about 12.4 billion against various charges and risks (including about 4 billion for a possible repurchase by the State of high-risk assets.)

The series of quid-pro-quos shows how a “pure bail-in” is scarcely feasible in practice, and highlights the intrinsic contradiction between the intention of European lawmakers and the reality of how markets work. Despite everything, in terms of stability and protecting depositors, the direct intervention of the State – which, in addition to guaranteeing the “good bank” also takes on the NPLs hived off into the bad bank and their management – remains absolutely necessary. It would be even better if this intervention could also be justified by the possibility for the State to recover non-performing assets and obtain medium-term returns (all of which remains to be seen), making the deal economically sustainable. Therefore, the heart of the issue is not the structure of the transaction, but rather the size of the stakes, reflected by the notional price of one euro and the amount of the various state guarantees.

The sale of the Veneto banks included more state protections than previous deals. The main one is Intesa’s right to return around 4 billion in high-risk performing loans to the State by the end of 2020.

It seems likely that the market will raise the stakes as rescues continue; it would be strange, for example, if Agricole Italia-Cariparma – the potential buyer in the rescue of the “Casse di Risparmio” of Cesena, Rimini and San Miniato – did not make demands in line with those of Intesa.


The future is not what it used to be

European authorities and national governments must take prompt, united action so that the aim of rationalising state aid does not produce the opposite effect: confining the State to a marginal negotiating position and inflating the role played by public intervention. Subordinating state intervention must not mean putting governments in a bind between compliance with European rules and market forces, expressed by the large, systemically relevant banks. It is not permissible to fix “state price ceilings”, nationalising only the losses and leaving the profits elsewhere.


We need to verify, using the actual figures, that the new resolutions – whether EU or domestic schemes – are actually less costly to the public purse than the old domestic procedures. Particularly in Italy, they must be less costly than the interventions used by our Interbank Deposit Protection Fund. At the moment that seems difficult to imagine. But as the poet once said, “The future is not what it used to be”.

[1] The absolute poverty line is the level of monthly spending that guarantees a basically acceptable standard of living. In 2015, Istat – Italy’s statistics office – set the absolute poverty line at 819 euro for residents of northern Italy, and 735 and 552 euro, respectively, for those in the centre and south of the country.

Good or Bad?

The Italian government’s pressure on Brussels has meant that national resolution procedures can be used, which should ensure greater freedom to protect bondholders than allowed by European rules.Il pressing del Governo italiano su Bruxelles ha consenito di adottare le procedere di risoluzione nazionali, che dovrebbero assicurare maggiore libertà di quelle comunitarie nella protezione degli obbligazionisti.

There is increasing uncertainty about the interpretation of the regulatory framework: when is a resolution subject to the European directive and when is it subject to national rules?

All the issues raised by the BRRD on the rationalisation of the use of public funds remain intact. Buyer banks are asking for ever more state guarantees and, as the succession of rescues continues, the trend is towards escalating requests for protection. Is that truly a bail-in?Aumenta l’incertezza interpretativa del quadro normativo: quando una risoluzione rientra nello schema della Direttiva europea e quando in quella nazionale?

Permangono intatti i nodi evidenziati dalla BRRD sulla razionalizzazione dell’impiego di risorse pubbliche: le banche cessionarie chiedono sempre più garanzie statali e, con il succedersi dei salvataggi, la tendenza è quella di un escalation di richieste di protezione: è vero bail in?

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