In Italy, 24-month parmesan and well-baked panettone crumble as well as sometimes Italian banks. This has been the case in the last months for the country’s third-biggest and the world’s oldest bank, Monte dei Paschi, conducting its top management to request state help on December 23rd.

The timing was indeed good: two days earlier, in a context of banking feverishness, the Italian parliament passed a bill to establish a €20bn fund to guarantee liquidity and strengthen capital for banks that request it. Paolo Gentiloni, Italy’s new prime minister, sought to be reassuring “today represents a turning-point [for the bank] and a reassurance for its depositors and its future”. In all probability, Monte dei Paschi will be bailed-out.

But how did the Siennese institution get to this situation?

Monte dei Paschi’s problems have actually been significant for years, as a consequence of mismanagement and bad timing. As an example, MdP bought in 2007 Antonveneta, another Italian bank, from Spain’s Santander for €9bn in cash. Therefore, it has already had two state bail-outs and wasted €8bn ($10bn) raised in share sales in 2014 and 2015.

As of the end of 2016, its non-performing loans (NPLs) represented 35.5% of its book value and its stock value has dropped in one year by 88%, to a €440m market capitalisation. Some €14bn in deposits were withdrawn in the first nine months of 2016. At the end of the year, the bank said that its €11bn of liquidity would only last four months.

Its troubles have been highlighted in July 2016, when the bank failed the European stress tests, ranking 51st of 51 lenders. The European Central Bank (ECB) responded to Monte dei Paschi that its capital shortfall had widened to €8.8bn, and urged it to find €5bn in equity by the end of 2016.

CHART 1: Italian bank’s share prices (€) in 2016 – Sources: The Economist, Thomson Reuters

CHART 2: Italian banks’ assets, as of Sept. 2016 – Sources: The Economist, Bloomberg

So, what did Monte dei Paschi do to resolve the problems?

A private rescue plan was designed in the summer 2016 between Monte dei Paschi and two investment banks JP Morgan and Mediobanca: €27.8bn-worth (gross) of bad loans would be offloaded into a separate entity and €5bn of equity injected in the streamlined structure of the bank. Those €5bn in equity would be raised partly through a voluntary debt-for-equity swap and partly through a sale of shares, secured with an “anchor” investor, likely to be Qatar’s sovereign-wealth fund.

The conversion raised €2.5bn, but the share issue failed, making therefore a state help plan unavoidable.

A state rescue plan is however not an easy move. The European Union has indeed strengthened its rules regarding state help to avoid the repeated bail-outs that European countries experienced after 2008. Under new European state-aid rules, bondholders as well as shareholders lose money (are “bailed in”) if governments bail banks out. Consequently, a bail-out of Monte dei Paschi, where 40,000 households own €2bn-worth of its bonds, would not be easy: making those small investors – who are usually depositors, too – bear the cost of the state rescue plan could have dramatic social and political consequences.

But they might be in fact spared. In the case of mis-selling, that is, investors not knowing or understanding the risks inherent to the bank products, banks can ensure that there are no adverse effects on retail investors. As part of the rescue, all junior bonds will be converted into shares.

Yet, if a complete bail-out might be complex, the European rules allows a “precautionary and temporary” bail-out to preserve financial stability. The bank must be solvent; the injection must be on market terms; and the capital must be needed to make up a shortfall identified in a stress test, like the one Monte dei Paschi failed in July 2016. The Siennese bank will undoubtedly undergo such precautionary bail-out.

The only question remaining is how much equity does the bank need? The ECB stressed the figure of €8bn capital requirements, but the exact amount will highly depend on Monte dei Paschi’s new business plan. In October 2016, the bank presented a plan to cut 2,600 jobs by 2019 and close 2,000 branches. A revised business plan is about to be presented in March and must be approved by the ECB and the Commission.

In the context of such uncertainties, the banking bill passed in December by the Italian parliament to create a €20bn liquidity fund has been warmly welcomed. It will definitely soften Monte dei Paschi’s troubles until the presentation of the revised business plan. What will happen next is however far from certain.

Spring, with Easter catholic celebrations and the start of the parmesan production, is a crucial time of the year in Italy. This year’s spring might also be a crucial to determine the fate of its oldest bank Monte dei Paschi and of its entire banking industry.



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The Economist