The Italian government is working on plans to set up a €50bn bad bank which would aim to clean up the country’s stricken lenders, the Sunday Telegraph reported.
Rising Cost of Credit Default Protection on Large Italian Banks
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Bank Stocks in Flames ahead of the News
It is understood that €10bn of public money could be used to buy bad loans at a knock-down price, taking assets with a face value of €50bn off the banks’ hands, allowing them to start giving out more good loans instead.
The scheme, which is being put together by JP Morgan, could help clean up the banks, but also puts the country’s authorities on a collision course with the EU, which does not want taxpayers bailing out banks before private investors take a hit.
The Road Ahead
First, it will all depend on Monti dei Paschi and how much capital they need. Out of the nearly 400 billion dollars of NPL’s in Italy, Monti dei Paschi is responsible for nearly 40% of them.
Second, a showdown between Italian State and the EU commission will surely come, we believe right after the 29th of July EBA (European Banking Authority) stress test results. This will be watershed moment for how Italian Banks capital requirements need to be addressed, if the number is too large and the Italian state cannot handle it, we will see renewed tensions as the ECB or Euro ﬁnance ministers will presumably have to step in.
The third possibility is a solution outside the BRRD directive (Bank Recovery Resolution Directive, explained in detail below), a legal ﬁx, which would not require a bail-in is needed, to get an end around the legislation. The EU court case on the 19th of July looms large, EU law vs domestic law, one outcome would be a strong case to non bail-in solution, or an unfavorable outcome that bounds Italy to bail-in and the strict interpretation of BRRD.
The Markit iTraxx Europe Senior Financial index comprises 30 equally weighted credit default swaps on investment grade European entities.
We get from this that it is implausible that we will get any resolution before the July 29th stress tests. The market at the moment seems to be pricing in to much clarity into a situation that is anything but. Article 32 of the EBA (see below for explanation) and the BRRD makes it very diﬃcult for Italy to save its banking system without serious compromises.
The BRRD is the key to bail-in life, and at this moment there is no reason to assume that this will be torn up. A couple weeks ago the ECB leaked a rumor with regard to the loosening of the capital key, if it became a reality, it would have positive ramiﬁcations for the Italian banking system.
The ECB will not make a decision on the key before its next meeting (we believe capital key expansion rumors are far from reality, especially one year ahead of German elections). Ultimately, some sort of skirt around the BRRD bail-in laws, which Article 44 section 3 of the EBA allows, coupled with ECB involvement will occur; BUT working this out will take much more time and political tension than the market is currently pricing in.