European View

How ECB’s hard line made MPS crisis unmanageable

by Marco Ferrando and Morya Longo

24 Exclusive content for IT24

Little over a decade has passed since the Bank of Italy Governor Antonio Fazio, in the name of stability, managed a banking crisis from behind the scenes by sweeping it under the rug. It looks like a century ago.

Today, the European Central Bank’s new Supervision regulator led by Daniele Nouy is following an opposite, Calvinist approach: flexibility and confidentiality have been replaced by inflexibility and publicity, without concerns about the consequences for the system.

The case of Monte dei Paschi di Siena confirms it. The Sienese bank has many problems, nobody denies it, but the ECB has played a crucial role in making these problems unmanageable, with spillovers for the entire Italian banking system.

Frankfurt first administered a bitter pill to Monte dei Paschi, based merely on the adverse scenarios in the stress test. It then set an irrevocable deadline, December 31, 2016, to resolve all the problems. It then denied any extension.

Finally, once it was clear that the state needed to step in, it changed its calculations and increased the capital shortfall from €5 billion to €8.8 billion. Nobody criticizes such decisions, based on a very deteriorated situation at the bank.

But a few questions arise: was the ECB right to impose drastic measures and irrevocable deadlines without considering the consequences that its decisions would have on the entire system? Was it right to make everything public, causing serious market turbulence which would finally make it impossible to carry out the rescue plan sought by the same ECB? Was it possible for MPS to take a different route and meet the same results without public money? Was it possible to avoid the contagion effects and the chaos in the entire Italian banking system?

Chronicle of a death foretold
Before trying to answer these questions, it’s worth reviewing the final steps of a crisis that has forced the state to rescue MPS.

It all started on June 23, 2016, when MPS emerged from the stress test as the worst European bank in a situation of extreme crisis. However, MPS was not insolvent and had positive net capital. It neither was loss-making, as it reported a first half profit of €302 million.

But removing bad loans from the balance sheet was rightly considered a priority by the ECB.
MPS approved a drastic plan: removing €27 billion of bad loans immediately and recapitalize for €5 billion.

The ECB approved the plan, but imposed a few conditions. One above all: the restructuring should not be completed in three years, as previously decided, but by December 31, 2016.

Beyond this deadline, according the ECB, MPS would need a bail-in. The deadline, ahead of a constitutional referendum that could worry investors, created turbulence on the market. MPS shares tumbled, outflows increased, subordinated bonds dropped. The entire Italian banking sector experienced turbulence on the stock market. It would have happened anyway, maybe, but without such a firm deadline for the death and life of the bank, there would have been less tension on the market.

After the “No” victory in the constitutional referendum December 4 that triggered the resignation of former Prime Minister Matteo Renzi, the situation worsened. Investors that were supposed to take part in the capital increase (starting from the Qatar fund) vanished. MPS asked the ECB for a 20-day extension but without success. No other solution materialized than a state bailout, penalizing the holders of subordinated bonds.

And when everything seemed resolved, the ECB’s Supervision (not unanimously) gave the final blow: since the state is now involved, the central bank has asked MPS to almost double the size of its capital increase than initially approved by the ECB, creating new uncertainty on the market: is it possible that a similar approach will be used in the future for other banks?