IREF - Institute for Research in Economic and Fiscal issues
Fiscal competition and economic freedom
Something is rotten in Italy, namely Italian bank loans amounting to € 360 billion. For around one out of five loans payback is doubtful. Such an imbalance in the Italian banking sector is a reminder of the financial crisis in 2008. In response to the crisis the European Single Resolution Mechanism (SRM) for banks was created. In case of a looming default of one of the big banks the SRM is there to ensure that the shareholders and creditors of the bank are held liable. Taxpayers should no longer bear the loss arising from actions of a few individuals. However, Italian prime minister Matteo Renzi shows no interest in triggering the SRM to take action, presumably because the creditors of Italian banks are predominantly Italian savers. This development provides some food for thought as it is not the first occasion where uniform European rules are not implemented uniformly.
Oldest Bank of the World threatened by Default
According to the European Banking Supervision, approximately 16.6% of all loans issued by Italian banks are under threat of default. The share of bad loans is one of the highest in the Eurozone and is only topped by significantly smaller countries such as Portugal, Slovenia, Greece and Cyprus.
Similar to other southern European countries Italy witnesses a decline in real GDP since the financial crisis. That just Italian banks are in the hot seat now is because of their long-standing lax lending practices.
16 banking groups with 68 subsidiary banks are classified by the European Banking Supervision as “important banks”. Many of these systemically relevant banks – among them the oldest bank in the world, Monte dei Paschi – got into troubles right after the Brexit-referendum. The volume of defaulted loans held by Italian banks amounts to € 360 billion, with the biggest share belonging to Monte dei Paschi, which holds € 46.9 billion of bad loans.
Standardised European Bank Resolution Mechanism
In order to avoid that taxpayers are held liable again for bank defaults in the future, the Single Resolution Mechanism took effect – a standardised European bank resolution mechanism. The related resolution fund will be financed through contributions from banks and will be created over a period of eight years. By 2023 there should be € 55 billion in the fund which should amount to around 1% of all covered deposits of all credit institutions in the banking union.
The banking supervision, organised as division of the ECB, will inform the committee of the bank resolution mechanism if a bank finds itself in economic distress or is defaulting on its debt. In an executive meeting of the committee it will be decided whether a private solution is possible or unwinding the institution is necessary. If the latter is regarded as the only solution, the committee will determine the resolution tools and the encumbering of the fund’s assets.
The main principle is the so-called Bail-In: Before the fund of the SRM releases any cash flows to the distressed bank of up to 5% of the receiving institution’s balance sheet, shareholders and creditors are required to suffer losses. A minimum of 8% of the bank’s balance sheet will be distributed between them, regulated by a binding sequence of liability.
Shareholders will be held liable by either diluting their shares through transforming debt instruments, simply deleting their shares or transferring them to former creditors. Creditors will be held liable by either (partially) writing down their claims against the bank or converting them to shares. In case that the involvement of Shareholders and creditors does not compensate the losses of the bank, deposits of over € 100,000 not covered by the deposit protection will be used.
A Promising Bank Resolution Mechanism?
The Single Resolution Mechanism looks very promising on paper. In practice, however, it still needs to prove itself and it does not look that promising in this regard. As long as banks are primarily financed by creditors from its home country, it might not be in the national government’s interests to let the SRM do its work. This is because in this situation a Bail-In of the creditors would mean that principally residents have to realise losses. Among them are not only potential voters, which the government wants to keep happy, but perhaps also members of influential interest groups,
For example, eight months ago the Italian government let four smaller banks go bankrupt, but introduced a solidarity fund in May this year to indemnify around 10,000 affected small savers of up to 80%. However, if it approves the unwinding of a bank like Monte dei Paschi through the SRM, there is a high likelihood that depositors with deposits of over € 100,000 and certainly also other creditors would have to accept losses.
It is therefore unlikely that the Italian government would let a big bank go bankrupt without shielding creditors from the negative consequences of their own investment decisions. Instead, it seems to prefer preventing creditors from facing losses by using taxpayer money – initially at the expense of the domestic taxpayers and later, if the Italian government itself gets into financial difficulties, in the worst case at the expense of all taxpayers in the Eurozone.
Two recent developments fit into this picture: First of all, the EU gave the Italian state green lights until the end of 2016 to give liquidity guarantees of up to € 150 billion in case of emergency to “solvent” banks with “temporary” liquidity squeezes. Secondly,the government is said to plan to supply troubled banks with € 40 billion without the participation of the SRM.
Conflict of Interest: EU vs. national Governments
The debate about transferring the affected Italian banks into the SRM uncovers a fundamental issue of all EU-Agreements. National governments have no incentives to carry on policies against well organised domestic lobbying groups or their own citizens’ interests, even though the entirety of EU-citizens would profit from it.
In the present case of Italian banks the EU deems creditor participation as indispensable, while the Italian government has an incentive to not intimidate interest groups or potential voters. The EU would therefore possibly be better advised to focus on achievements like the single market which profits almost all citizens in all countries. Not for every problem for which there exists an attractive EU-solution on paper, can the solution be implemented at the EU Level in the real world.
This article is a translation of an original piece published on our German site and available at http://de.irefeurope.org/Italiens-Banken-Bail-In-oder-Bail-Out,a1161