Analyse fra Commerzbank
Italy’s banking system with its many non-performing loans is moving into market focus again. Investor bail-in according to the pure doctrine of the EU is just as unlikely as broad-based state aid. Instead, Italy will probably continue to muddle along. Other countries in the euro zone are also shying away from a big clean-up of their balance sheets, which will further dampen the economy and entice the ECB towards a loose monetary policy.
What is more, Italy’s avoidance of EU restructuring rules is symptomatic of how EU rules are being handled. The problem is bad loans The problem of Italian banks can be summarised in one figure: €333 bn. This is the sum of bad loans reported by the Italian central bank at the end of the first quarter which amounts to 16.4% of all bank loans (chart 1).
Italian banks have written off the bad loans in the narrower sense to around an average of 40% of their nominal value. But a sale would probably bring only 20% to 30% of the face value, leaving a gap of 10% to 20%, corresponding to about 30 to 60 bn euros. The Italian government has quantified its capital requirements at 40 bn euros. If banks were to write off bad loans according to their true value, many would not have enough equity capital to meet the minimum requirements of the banking supervisors.
Bail-in or bail-out – or none of the above? There are essentially two ways of closing the capital gaps. Either the creditors of Italian banks pay (“bail-in”) or the tax payers do (“bail-out”)3 :
• “Bail-in“ of investors – too many small savers affected: If banks cannot close capital gaps through additional private capital, the EU resolution and restructuring rules say that investors – meaning shareholders and external creditors – have to be called upon (see box). It is unlikely though that the Italian government will respect the spirit of these rules. After all, many private investors, including many small savers, hold deposits in the form of bank bonds, which could be hit by the “bail-in”.
At the end of last year, such investors in subordinated bonds were called upon in the case of four banks, but the government is unlikely to want to repeat such an unpopular measure, especially as senior bonds for private investors could now also be affected at many banks, and the referendum on the reform of the Italian Senate will be held in the autumn, to which Prime Minister Renzi has linked his political fate.
Borrowers are not only in payment default but are insolvent. Furthermore, the common regulations for the recovery and resolution of banks have applied since the beginning of 2015. The third element of the Banking Union – a common deposit protection – has not been implemented to date.
According to the so-called EU Bank Recovery and Resolution Directive (BRRD) shareholders and creditors of the bank concerned first have to accept losses corresponding to at least 8% of the liabilities of a bank (bail-in) before the state intervenes (bail-out). That said, numerous creditors of the bank are excluded from this: all deposits under 100,000 euros (as they are covered by the deposit protection), secured liabilities, certain interbank instruments and salaries and tax debts.
Given these numerous and broad exceptions, the burden on other creditors ends up being quite high. This rule can be avoided if its application leads to systemic risks, e.g. if insurance companies hold bank bonds on a large scale and could themselves run into major difficulties through such a bail-in.
This applies all the more because such a bail-in of private investors would also have a noticeable impact on the banking system, at least for a while. After all, banks would then not be able to place bonds with this important Italian investor group. There would even be a risk of private investors reacting to the losses by withdrawing their deposits, resulting in a capital flight.
• “Bail-out” by the state – only in the case of severe market distortions: Not only is the “bail-in” of investors under EU rules unlikely but so is the broad-based “bail-out” by the Italian state. After all, government aid – Renzi has hinted at 40 bn euros – is only permitted without investor participation under EU rules if there are systemic risks.
And the other EU member states will probably only see these risks if significant market distortions occur, as was the case after the Lehman bankruptcy, and these are not evident so far. Rather than recapitalisation of the banks via investor participation or a huge capital injection from the state, a combination of various measures is more likely.
There may be some government assistance in single cases if it can be justified under the European rules. For example, Italy could make use of the derogation provided for in the recovery and resolution rules in the acute case of the Monte Dei Paschi bank, according to which a temporary state capital measure is permitted if a capital gap is identified for a bank in the course of a stress test. The results of the current stress test will be published on 29 July.
Regarding other troubled banks, the government will probably continue to rest its hopes primarily on the “Atlante” fund set up in April, and on hopes of a slightly brighter economy. That said, the fund is unlikely to be big enough, even after any enhancement, to resolve the problems of the banking system on a sustainable basis (box, p4). Instead of any great breakthrough, the muddling-through approach of past years is set to continue.
Muddling-through is symptomatic of all of the euro zone No real clean-up: The fact that Italy has avoided a real clean-up of its banking system ultimately reflects its lack of willingness to bear the pain of correction. Indeed, private owners of bank bonds suffer if they are called upon to restructure. This pattern can be seen throughout the euro zone. After corporate and private-sector debt had risen at a much sharper rate than GDP in the years before the crisis, the debt ratio has since decreased only very slowly (chart 2, page 2).
This has prevented any crisis triggered by a debt reduction, but as this debt continues to weigh heavily, businesses and private individuals have been showing spending restraint for years which prevents the euro zone economy from recovering properly, and which is enticing the ECB into a loose monetary policy. The euro zone thus differs from the US, where private-sector debt decreased relatively quickly after the housing bubble burst in 2007. In the USA, banks can start foreclosure processes much sooner.
The US government practically compulsorily recapitalised all large US banks at the peak of the crisis in 2008. All in all, balance-sheet adjustment in the USA advanced rapidly and banks, businesses and private individuals could act free of a debt burden. This largely explains why the US economy has recovered much faster, and there is virtual full employment in the USA, unlike in the euro zone.
The Italian government is doing everything to make full use of the exceptions in the EU restructuring rules. While this is not openly breaking EU rules, it does constitute a breach of the spirit of these rules. The effect is similar of course. Investors learn that they do not have to expect European rules to be implemented consistently.
This harms the credibility of the recovery and resolution rules. Investors in other countries in future will thus not expect to be asked to contribute, as planned, when banks run into difficulties and have to be restructured.
The yields of senior and subordinated secured bonds do not reflect the true economic risks, which dilutes the disciplinary effect of the market on banks. Circumvention and stretching of rules is symptomatic of the whole euro zone. A case in point is the non-bail-out clause in the Maastricht Treaty, which should originally have prevented EMU countries from being liable for the public debt of other member states.
This rule should ensure that individual states feel the consequences of unsound fiscal policy directly in the form of higher yields, which should create an incentive to obey the rules. But the markets never believed in this rule and yields in Spain and Italy could therefore fall close to those on Bunds before the sovereign debt crisis. A further example of rule breaking is the Stability and Growth Pact.
For years, the EU Commission has refrained from punishing budget offenders. The EU Commission President practically exposed the rules to ridicule recently when he justified the Commission’s leniency towards France’s violation of the rules on television with the words: “Because it is France.”
