Italy is finding itself right in the middle of Europe’s banking crisis. Every bank has bad
loans from time to time. In Italy, the number of bad loans appears to have leveled off.
So why then are shares of Italian banks continuing to free fall? The reason is in part
because the bad loans held by the weakest Italian banks may need to be paid for by other
(stronger) Italian banks.
Last November, four small troubled Italian banks were merged and recapitalized,
turning four failing banks into one larger healthy bank. The bad loans were booked into
the new bank at just 20% of their face value, allowing the new bank to profit on the bad
loans. This fix came at no cost to taxpayers. Instead of using taxpayer funds, healthy
banks were forced to make contributions over the years into a “resolution fund.” This
fund was used to bail out the failing banks.
Historically, this system (fair or not) has been working in Italy. The trouble is
that the number of banks needing bailouts is exceeding the amount of money the healthy
banks can offer before they find themselves in financial trouble. This scenario is
repeating itself all over Europe.
The poster child for this concern is the world’s oldest bank, Italy’s Monte dei
Paschi di Siena (which happens to also be Italy’s third largest bank by asset size).
Although still considered “strong,” Monti dei Paschi has troubled loans of its own. Due
to the above-average supply of bad loans being sold in the marketplace, the prices offered
for these loans has fallen to around 30% of face value. Selling off all of those bad loans
would force Monti dei Paschi to reduce their face value from €46.9 Billion to €12.5
Billion. A reduction to their assets of this size is greater than the bank’s common tier one
equity (meaning that selling all these troubled loans today at 30% of face value would
extinguish the bank’s healthy equity position).
To make matters worse, ordinary Italian savers tend to hold lots of bank bonds.
Many of these individuals lost money when banks failed in the past. The outcry from
everyday savers caused the Italian government in December 2015 to create a new €100
Billion compensation fund, to prevent future bank failures by forcing other banks to
Monti dei Paschi is a great example of the American phrase Too Big to Fail. A
failure of the world’s oldest bank would cause ordinary investors to lose significant
savings in the form of bank bonds. At the same time, continuing to have healthier banks
fund failing banks is a solution that cannot last forever.
Many experts believe that Monti dei Paschi needs a merger. Two banks that have
recently been mentioned are UniCredit and UBI Banca. Reform and consolidation of
Italian banks is coming slowly, but Monti dei Paschi is the most pressing problem.
Failing to find a solution will cost all Italian banks dearly.
“Italian Banks are all in it Together – and That’s the Problem.” WSJ. 15 Febr 2016.