Tuesday , March 26 2019

Italy’s revolution is gone in 480 seconds

It took Italy’s populists just eight minutes to renege on one of their flagship stances. The coalition government gave its go-ahead to a bank bailout, saying it is willing to recapitalise Banca Carige, a troubled mid-sized lender, if needed.
The plan smacks of hypocrisy. For years, the Five Star Movement has accused its political opponents of using public money to help the banks instead of supporting ordinary citizens. Most important, it may not work. It’s not clear that Italy can inject public money into Carige without breaking the European Union’s state-aid rules.
Rome’s scheme gives Carige the possibility of issuing bonds with a government guarantee. That will make it easier for the bank to retain access to the funding market, at a time of deep stress. The European Central Bank (ECB) put the lender in special administration at the start of January after shareholders failed to agree to a capital increase.
The recapitalization part of the plan is more surprising. The populists say they’re willing to do this so Carige can meet its capital requirements even under a stress test. In other words, Five Star is willing to inject money into a bank, having lambasted the center-left Democratic Party for doing the same with Banca Monte dei Paschi di Siena SpA.
Indeed, the plan is in perfect alignment with the policies of previous governments. The same liquidity guarantees were issued to Veneto Banca and Banca Popolare di Vicenza, two lenders that were eventually liquidated, as well as Monte dei Paschi in the recent past. So much for Italy’s populist revolution.
Accusations of hypocrisy might not be the worst thing Italy’s populists have to worry about, however. The scheme, as currently designed, may not work. The chief problem concerns those EU state-aid rules, which put stringent conditions on the “precautionary recapitalisation” envisaged by the government.
For a start, the process is only allowed to remedy a serious disturbance in the economy of a member state and preserve financial stability. Carige only has about 25 billion euros ($32 billion) in assets, far too small to consider it systemic. Italy’s other banks are better-capitalized than in the past, making it harder to argue that there would be a domino effect from an
orderly liquidation. The financial markets have shown little sign of contagion.
The Venetian banks precedent is also important. In June 2017, the EU body that manages bank failures decided that the two lenders weren’t eligible for resolution since they weren’t systemic. At the time, they had assets of 28 billion and 35 billion euros respectively, slightly bigger than Carige. If BPVI and Veneto Banca could go bust, why not Carige?
There’s another requirement in a precautionary recapitalization that shareholders and junior bondholders must face losses before the state can inject in money. This would mean some retail investors losing their money, creating a political problem for Italy’s leaders.
Five Star and its partners in the League have promised to return money to investors in banks that went under in recent years. In their 2019 budget, they included a 1.6 billion euro fund to compensate retail junior bondholders and – incredibly – shareholders up to, respectively, 95 percent and 30 percent of their original investments. So it would be very hard to then impose losses on ordinary citizens who invested in Carige.
Of course, the two parties could pledge to refund them too. But would Brussels approve the operation if it knew Rome would circumvent the rules by offering generous ex-post relief? And even if it did, it would probably impose conditions and limits. Brussels is yet to say what it thinks of the compensation scheme in the 2019 budget law. It might well find it in breach of state aid rules.
None of these awkward questions needs to be answered straightaway. The bank could yet find an entirely private solution to strengthen its capital base. An industry fund has issued a 320 million-euro subordinated bond. Carige could merge with a partner, though it’s hard to see that given its low profitability and big bad-loan book.
So expect Carige to haunt Italy’s rulers for some time. This week may be just the first of many rude awakenings.

—Bloomberg

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