The Italian banking system; the EU the ticking fiscal ‘time bomb’

Italy’s third largest bank, Monte dei Paschi, one of the oldest banks in the world, is on the brink of needing a State bail out yet again, after efforts failed to convince private investors to provide fresh capital. A last ditch attempt to persuade Qatar’s sovereign wealth fund to invest in the bank failed spectacularly, and the hope for other efforts to raise money to prop up the bank have been dashed.


Failing a last ditch surprise capital bail out, Monte dei Paschi will miss the European Central Bank’s Dec. 31 deadline to raise 5 billion euros ($5.2 billion). The Italian parliament has had to authorised 20 billion euros in new public debt on the December 21 to inject into Monte dei Paschi and other smaller banks in case the required private capital funding doesn’t eventuate. Italian media have claimed that the government’s bail out plan for Monte dei Paschi could take up to three months to facilitate. Starting with a State guarantee of the bank’s borrowing to ensure that Monte dei Paschi doesn’t run out of liquidity initiating a ‘run on the bank’. Currently the Bank claims to only have available liquidity to take it to the end of March 2017.

Italian politicians have tried to reduce uncertainty about the country’s financial sector in the face of political turmoil. When the former Italian Prime Minister Matteo Renzi resigned after losing a referendum Dec. 4, the Italian parliament quickly formed a new government to reassure markets. The Prime Minister changed but the underlying make up of the Italian administration didn’t. The parliament’s authorization of fresh money to shield Monte dei Paschi specifically and its associated the banking sector, to reduce the panic of yet another growing insolvency crisis in the Italian banking sector. No new initiatives have been forthcoming however and the same old ‘bail-out and hope’ mantra remains

Any rescue program for Monte dei Paschi will again cost thousands of Italian retail investors massive losses. The new ‘EU rules on bank bail-outs’ require bondholders and people with savings over 100,000 euros to take a ‘haircut’ in case of State intervention —a process unkindly known as “bail-in.” Another major bond and savings loss will be political dynamite, because many of Monte dei Paschi’s bondholders are pensioners and middle-class households, who are already on the financial ropes.

The Italian government has been in talks with EU institutions (read German banks) over ways to compensate the estimated 40,000 retail holders of ‘junior debt’ (over 100,000 euros)  who will suffer significant loss. Fear that bond holders, as well as nominally unaffected savers (below 100,000 euros), ‘junior debtors’ (in excess of 100,000 euros) and  investors in other associated banks, could face a similar fate, that would generate a run against Italian banks, and potentially a contagion across the rest of the eurozone countries.

Additionally, a messy ‘bail-in’ process (fiscal shorthand for a financial ‘haircut’ for savers) could further damage the Italian government and boost the popularity of anti-establishment forces, especially the anti-establishment Five Star Movement party, that has accused the Italian government and EU banking elites of working against the interest of Italian families. Italy currently has a very fragile government, and early elections will take place in 2017. A victory by the Five Star Movement, which wants an ‘Italexit’  referendum which cannot be ruled out when the elections are held.

Finally, there is the probability that any 20 billion euro rescue package for Monte dei Paschi, and other smaller institutions, will not actually achieve anything substantial and will not solve Italy’s banking problems. Italy’s banks have 360 billion euros in bad debts (roughly 18 percent of total loans), a consequence of decades of economic stagnation, high unemployment, bad loans, corruption and lack of reform in the banking sector. Over the last few years, Italian banks have been trying to ‘package’ and sell these sub-prime toxic loans to private companies as CDOs (Collateralised Debt Obligations), or BTOs (Bespoke Tranche Opportunities). Merely fiscal jargon for Shorting  ‘garbage loans’. The results, understandably after the melt down experience of 2008, have been ‘rather patchy’ to say the least.

So far, Italy has avoided a massive bail-out like the one Spain requested in 2012. Whatever the Italian government chooses to forestall Monte dei Paschi’s collapse, Italy’s banking problems will eventually trigger a political solution that will have existential ramifications for the EU as a whole.