Italy bails out banks with taxpayers’ money

Although it was already apparent in the last few days, it is now official since Sunday evening: the crisis-ridden banks – Veneto Banca and Banca Popolare di Vicenza – will be liquidated and wound up under Italian insolvency law. The EU Commission had already approved the plan yesterday evening. Given that the two institutions, which were classified by the ECB as failing or likely to fail, are not systemically important banks, they can be wound up under national insolvency legislation.

The Italian government is likely to score the solution found as a political success. It would have been a disaster for the social democrats, who were seen to be foundering in the polls, if private investors had incurred losses. Both the left-wing and right-wing populists could have exploited this to their benefit in the forthcoming election campaign. However, political success comes at a price. The entire rescue package corresponds to 1.2% of GDP. In times in which Italy is already scaling back its cost-cutting efforts, the bailout funds place a burden on the public finances and will be fully charged to the debt ratio. While most EMU states are at least reducing their sovereign debt further to some extent, it is still too early to talk of a trend reversal in the case of Italy. Only a few days ago, the Minister of Economy and Finance Padoan spoke out and maintained that Italy had to fend for itself again in fiscal terms after the end of PSPP. The government will now have to mobilise all of its resources to not only convince investors of the stability of its banks but also of Italy’s long-term ability to sustain debt.

The new rules for winding up banks therefore do not apply in this case. Although shareholders and subordinate bondholders will participate in the resulting losses, the Italian government will bear any additional costs and risks, such as those incurred in conjunction with non-performing loans or the compensation paid to dismissed employees. On the other hand, Intesa Sanpaolo set tough conditions in the negotiations held in the last few days and is paying a nominal sum of one euro for the “cream” of both banks. The senior bondholders and depositors of both banks remain unaffected and the branches – as a part of Intesa – can open as normal this morning. The Italian government has therefore achieved its most important goal.

The approach taken in Italy therefore differs from that taken by Spain a few days ago in relation to Banco Popular. Although the senior bondholders and depositors there are not affected, big bank Santander is taking over all parts of the failed Banco Popular for a symbolic price of EUR 1 and will carry out a billion-euro capital increase. The Spanish government is therefore not involved in the bank bailout, whereas Italy could face charges of up to EUR 17bn.

This proves that we are still in a transition period with regard to the treatment of failing banks. Strictly speaking, the new rules on banking resolution and restructuring ought to have probably been applied in the case of the two Italian banks. However, what consequences would this have had in what is already a weak economic environment? Private savers in particular, whose senior bank bonds were once sold as a more or less “secure” investment opportunity without being given the relevant information, would have been affected by the firm application of the new bail-in rules. The consistent application of the new rules could probably have had a distinctly negative impact on the already fragile Italian banking market, not least in the form of higher refinancing costs. However, the approach now taken in Italy should and may not blind us to the fact that stricter application of the bail-in rules will become ever more likely with the passing of time and a growing “acclimatisation” of the market to resolutions and bail-ins – especially since senior bank bonds will then be sold to private households with a different explanation about potential risks and bought by them with a different understanding of risk.

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