Handelsblatt Exclusive E.U. Backs Italy's Bank Bailout – in Principle

The bailout of crisis-torn Italian bank Monte dei Paschi has overcome its first hurdle in Brussels, according to E.U. diplomats. But the rescue, questioned by Germany, is not yet certain of E.U. approval. Creditors still need to pay a price too.
The bank needs a bailout. Brussels may allow it to get one.

Monte dei Paschi di Siena, Italy's third-largest bank, appears to have passed the first hurdle to be granted a state bailout by E.U. authorities in Brussels, according to E.U. diplomats, but only if the bank meets a series of tough conditions that include taking money from its creditors and shareholders.

As far as the European Commission in Brussels sees it at least, the basic prerequisites for a rescue package have been fulfilled. Italy is considering a “precautionary recapitalization” and the commission, which needs to approve state aid to private companies, sees this as legally allowable, the E.U. diplomatic sources told Handelsblatt.

Monte dei Paschi di Siena, the world's oldest surviving bank founded in 1472, is waiting for a capital injection from the Italian government. Struggling with a bad loan portfolio of €45.6 billion, or $48.3 billion, and unable to attract new investors it applied for a bailout last month.

The state can only step in to rescue Monte dei Paschi if the bank's shareholders and creditors also make sacrifices.

Without state aid, Monte dei Paschi would likely go bankrupt and possibly bring down other Italian and euro-zone banks as well, triggering another bank crisis that hit the 19-nation euro zone in 2008-2009. A bankruptcy would also have devastated the savings of thousands of Italian savers.

The partial nationalization, however, is subject to E.U. approval. E.U. regulations only allow state aid to private companies under certain conditions. The European Commission, the E.U.'s executive body and antitrust regulator, has been reviewing the deal since its announcement.

The bailout is also politically sensitive. Germany has raised concerns about the plan's compliance with E.U. rules after the bank requested state aid last month. According to Reuters news agency, the euro-zone finance ministers plan to discuss the “compatibility” of Italy's bailout for Monte dei Paschi with European Union rules at their next regular meeting set for January 26.

The E.U. banking directive allows “precautionary recapitalization” under two conditions: firstly, the financial institution must be viable in the long term. E.U. diplomats say this condition has been met. The institution is making a profit and has passed the stress test of the European Central Bank (ECB) under normal conditions. Only in a severe economic downturn would a capital gap actually lead to a crisis scenario.

The second condition relates to whether the bank's collapse would endanger the financial system generally. In the opinion of the commission, this criterion has also been met. The European banking sector was shaken to its roots in the financial crisis of 2008 and has still not fully stabilized, according to the Brussels diplomats, and therefore shouldn't risk the collapse of Italy's third-largest bank.

However, that does not give the Italians a free pass. The state can only step in to rescue Monte dei Paschi if the bank's shareholders and creditors also make sacrifices. This burden-sharing must be guaranteed before the E.U. competition authorities can approve state aid for Monte dei Paschi, according to E.U. diplomats. In addition, the bank must put forward a restructuring plan which would ensure the bank's sustainable profitability.

It's all part of a controversial set of new rules in place since last year, agreed in the aftermath of the euro zone's debt crisis. Supporters argue the rules make state bailouts less likely, but some detractors in the financial sector believe forcing creditors to bear the burden puts banks at greater risk of collapse by discouraging investment in the first place. Italy has been pushing for only limited losses for creditors.

The state can only begin to disburse the billions in aid if it's in line with E.U. competition guidelines. That means Monte dei Paschi has little choice but to comply with the strict conditions. Shareholders will have to accept a significant dilution of their holdings. The bank's bonds will also have to be converted into shares, meaning institutional investors, who account for more than half of all the bank's investors, would lose money.

For small investors, who bought shares in Monte dei Paschi as part of their retirement funds, there's room for hope. There are clear signs that the bank misrepresented their bonds as a secure investment and didn't warn of the risks, according to Brussels sources. Bad advice from the bank clears the path for some of those who lose money on their bonds will be entitled to compensation.

There is a caveat: Only savers who bought newly-issued bonds of the bank can take advantage. Those who bought bonds traded on the secondary market will be unable to claim for compensation.


Ruth Berschens heads Handelsblatt's Brussels office, leading coverage of European policy. To contact the author: [email protected]