Blog Post

Italy’s Atlas bank bailout fund: the shareholder of last resort

Italy’s new bank fund Atlas might be what is needed in the short run, but in the longer term the fund will increase systemic risk. What ultimately matters is how this initiative will affect the quality of bank governance, a key issue for the future resilience of the system.

By: Date: April 22, 2016 Topic: Finance & Financial Regulation

Makronom

This blog post was also published on Makronom.

In Greek mythology, Atlas the Titan was condemned by Zeus to eternally hold the weight of the sky on his shoulders. A mythological struggle that has recently made the news, thanks to the creation of a new Italian bank fund named after the titan, and facing the equally tough duty of sustaining the weakest pillars of the Italian banking system.

Several issues remain with the new fund which deserve discussion. First, the fund may avoid the need for bank resolution in the short term, but increases systemic risk in the longer term. Second, the role of the state is dubious and should be spelled out for reasons that go well beyond state aid considerations. Third, the extent to which this is also an initiative to preserve the Italian ownership of Italian banks is unclear.

The Issue

Italy’s bank fund was announced on 11 April, before Italian banks Banca Popolare di Vicenza and Veneto Banca undertake important capital increases. The fund is expected to raise 4-6 billion euros, and act as a backstop to shore up confidence in the Italian banking sector.

In practice, its mission is to “ensure the success of capital raising requested by the supervisory authority for banks that face market difficulties”, by acting as a subscriber of last resort. It also aims to buy mezzanine and junior tranches of securitized non-performing loans (NPLs).

Out of the 360 billion euros of Italian NPLs, the more serious bad debt (“sofferenze”) accounts for 14% of total loans on average (about 200 billion euros), with a coverage ratio of 59.8% (see table 1).

Assuming a price of 20 cents on the euro (in line with the cases of previous resolution), banks would be covered for 79% of the nominal value of their impaired assets, while the remaining 21% would face a net loss of 42 billion euros on bad debts (or 2.6% of Italian GDP).

In perspective, it’s a much smaller amount than what other countries have pledged in support of their banking system, and had this happened years ago, the state could have covered it. But today the picture is different.

NPLs in Italian banks

Source: Atlas confidential draft leaked to Il Messaggero

NLP Italian Banks

Systemic re-shuffling

The systemic implications of the fund’s structure and role have been downplayed in the debate. After the two episodes of bank resolution conducted last year (discussed here and here), there is one fact that could not be clearer: in a country where about a third of bank bonds is held by the household sector, even a limited bail-in can have painful consequences for people’s lives.

A leaked draft of the Atlas project suggests that the initiative stems from fears of the systemic implications if Banca Popolare di Vicenza and Veneto Banca failed to raise enough capital. If this were to happen, the document warns on page 2, there would likely be bank runs due to depositors’ worrying about bail-in, increases in the cost of funding, losses on direct and indirect bank exposures, losses on households’ investment portfolios including bank debt, and negative effects for the real economy.

Salvatore Rossi, Director General of the Bank of Italy, recently stated that Atlas will reduce systemic risk, by avoiding “fears of a ‘domino effect” due to the difficulties of individual banks. However, the structure of the fund would suggest otherwise.

The fund will be mostly financed by Italian banks and privately held institutions. Recent reports suggest that the two largest Italian banks, Intesa and Unicredit, will contribute 1 billion euros each, one additional billion will come from other banks, 500 million from banking foundations, 500 million from the publicly controlled Cassa Depositi e Prestiti, and the rest from Italian insurance companies.

By acting as a shareholder of last resort for those banks that are too weak to raise capital on the market, the fund effectively prevents bank resolution (and its consequences) in the short run. But it does so by piling up risk onto the balance sheets of a banking system that is already very interconnected, and that at present retains areas of weakness.

It’s hard to see how this would reduce the risk of a domino effect in the long term. Scepticism is reflected in the assessments of Fitch and S&P, which both point out that the fund increases the exposure of stronger banks to weaker banks, with negative prospects for the stronger banks’ creditworthiness.

Concerning confidence – which the fund is expected to increase by acting as a buyer of last resort – the effect is at best dubious. Ideally, a backstop should be reassuring enough for it never to be used, but considering the sense of urgency surrounding Atlas, this is unlikely to be the case.

In fact, recent news reports suggest that investor demand for shares issued by Banco di Vicenza is poor, and that the total unsold portion could total no less than 1 billion euros. Atlas will cover the gap, but should a capital raise that succeeds only thanks to the unconditional commitment of a buyer of last resort be considered a “successful” capital raise? And is it reasonable to expect that increasing exposures of stronger banks to weaker banks will enhance confidence in the health of the Italian banking system as a whole?

What’s made in Italy, stays in Italy

The extent to which this fund is aimed at preventing foreign takeovers of Italian banks is unclear. On March 29 US private equity fund Apollo offered to buy a majority stake in Italian bank Carige as well as the bank’s 3.5 billion euros of NPLs, and media reports suggest the bid was also viewed favourably by the ECB. A recent Repubblica article suggested that the objective of the bank fund “is also to prevent the arrival of foreign funds, able to put on the table enough resources to buy NPLs and recapitalise the banks acquiring control, as Apollo is trying to do with Carige”. Similar interest was expressed by US fund Fortress for Banca Popolare di Vicenza, but the idea was abandoned earlier this month.

Italian finance minister Padoan speaking in Washington at the Peterson Institute of International Economics on April 14 dismissed this as “gossip”, arguing that the fund is not aimed at preventing foreign entry, but to prevent the dismissal of Italian banks’ assets at fire sale prices.

As always, the key question is what the market price for these assets is. The fund may not have the explicit objective of limiting foreign entry, but if the “fire sale” prices at which foreign investors are willing to invest reflect actual market value, than by buying at higher prices the fund keeps out foreign investors and subsidizes the banks shedding those assets. Perhaps more importantly, it achieves this by buying assets at a higher cost than they are worth, and funding this mostly within the rest of the Italian banking system.

The argument in favour of this is that if the NPL scheme succeeds and growth picks up, then the value of these assets will recover enough to make the operation profitable, so the fund buys banks the precious time they need for their assets to become appealing to foreigners at a higher price.

The obvious counterargument is that the Italian banking sector has spent the last 5 years trying to buy this time, with the result that it now has to set up Atlas to avoid resolving those banks that should have recovered but did not. The experience of this delayed clean-up would suggest that more time is not always enough, and that this is a risky bet. An important test for Atlas will be whether foreign investors will eventually invest in it.

Unclear nature

While there have been reports that the fund is “government-inspired”, the Italian government has stressed its private nature (see minister Padoan here, the government website here). This is key to prevent the fund’s operations from being classified as state aid by the European Commission, but it also matters in relation to the structure of the recently approved state guarantees scheme for NPLs, known as GACS in Italian.

The GACS scheme foresees a state guarantee on the less risky senior tranches of securitized NPLs, but before the guarantee can be activated, 50% of the less senior tranches need to be placed with private investors. The market appeal of these riskier tranches is low, or rather the market price could be very different from the value at which the NPLs are accounted for on banks’ balance sheets, which would translate into impairments and consume capital.

So the guarantee scheme for Italian NPLs runs the obvious risk of stillbirth unless Italian banks pool their funds together into a private fund and buy a significant part of the junior products themselves, which is precisely what Atlas will do.

Yet, if this is supposed to be a fully private initiative, it is not clear why it should include a 500 million euro contribution from the Italian National Promotional bank Cassa Depositi e Prestiti, which is a joint-stock company under public control.

The role of Cassa Depositi e Prestiti (CDP) should be clearly spelled out. The rationale for transparency goes well beyond state aid considerations. A first reason is that the fund will buy unsold shares from those banks that have been asked to raise capital by the supervisor: the involvement of a publicly controlled institution as a buyer of last resort could cast doubts on the strength and impact of supervisory action.

Take the example of Banca Popolare di Vicenza, which is raising capital for the third time in three years. Normally, if a supervisor requests that a bank raises capital and the bank fails to do so the bank is put into resolution.

In the Italian case, if Banco Popolare di Vicenza fails to raise capital later this month, the fund (in which CDP participates) will step in to ensure that the resolution threat is removed regardless from the market outcome. In this scenario, the strength of supervisory action is reduced.

Moreover, avoiding a bank resolution will also prevent the change in governance structure that the resolution authority can demand from a bank. Considering that the previous cash calls of Banca di Vicenza are now under investigation, after an ECB inspection revealed that the bank had loaned money to customers to buy the shares and that in some cases managers allegedly signed letters guaranteeing the bank would return or repurchase the shares, a change in governance appears to be highly warranted.

A second reason is that the fund will become shareholder of relatively weaker banks in the system and buy relatively riskier NPLs tranches. The rationale for involving into such operation the CDP, which manages a large share of Italian savings, should be transparently discussed.

Conclusion

The Atlas fund has a heavy task, although probably not as heavy as that of its mythological namesake. In the short run, it might be what most commentators have described: an imperfect but needed second-best way to avoid bail-in and resolution, matching repeated calls from the Bank of Italy for a revision of the Bank Recovery and Resolution Directive (BRRD) framework after Italy negotiated and approved it.

However, by acting as a bank shareholder of last resort the fund increases systemic risk in the longer term, weakening the stronger banks and involving a publicly controlled institution whose main source of funding is postal savings into a rather risky venture.

While it’s unclear whether the aim is to keep foreign capital out of the Italian banking system, what ultimately matters is how this initiative will affect (or avoid affecting) the quality of bank governance, a key issue for the future resilience of the system. Regardless of whether we think that keeping weak banks alive at all costs is a good idea, the idea of such a shareholder of last resort appears at odds with the aim of making progress towards a solid European Banking Union.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article More on this topic More by this author

Blog Post

Croatia’s path into the banking union

Croatia seems a suitable candidate for euro area accession: there is a tight peg to the euro, high public debt is coming down, and the banking sector is already dominated by euro area banks. But the Eurogroup has rightly targeted reforms of the state’s role in the economy as a precondition for participation in ERM II and the banking union. None of the announced reform plans are new or easily concluded within the timeframe that has now been agreed.

By: Alexander Lehmann Topic: European Macroeconomics & Governance Date: July 18, 2019
Read article More on this topic

Blog Post

‘Lo spread’: The collateral damage of Italy’s confrontation with the EU

The authors assess whether the European Commission's actions towards Italy since September 2018 have had a visible impact on the spread between Italian sovereign-bond yields and those of Germany, and particularly whether the Commission’s warnings have acted as a ‘signalling device’ for bond-market participants that it might be difficult for Italy to obtain the support of the ESM or the ECB’s OMT programme if needed.

By: Grégory Claeys and Jan Mazza Topic: European Macroeconomics & Governance Date: July 8, 2019
Read article More on this topic More by this author

Blog Post

The breakdown of the covered interest rate parity condition

A textbook condition of international finance breaks down. Economic research identifies the interplay between divergent monetary policies and new financial regulation as the source of the puzzle, and generates concerns about unintended consequences for financing conditions and financial stability.

By: Konstantinos Efstathiou Topic: Finance & Financial Regulation Date: July 1, 2019
Read about event More on this topic

Past Event

Past Event

Sound at last? Assessing a decade of financial regulation

What has changed since the financial crisis of 2008 that makes the financial system sound at last? Is regulatory reform going in the right direction? Has it run its course? 

Speakers: Patrick Bolton, Rebecca Christie, Maria Demertzis, Mathias Dewatripont and Xavier Vives Topic: Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: June 20, 2019
Read about event More on this topic

Upcoming Event

Oct
29
08:30

Bank resolution: its impact in the EU

Closed-door workshop on various aspects of bank resolution.

Speakers: Jon Cunliffe, Martin J. Gruenberg and Elke König Topic: Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Blog Post

GNI-per-head rankings: The sad stories of Greece and Italy

No other country lost as many positions as Greece and Italy in the rankings of European countries by Gross National Income per head, between 1990 and 2017. The tentative conclusion here is that more complex, country-specific stories – beyond the euro, or the specific euro-area fiscal rules – are needed to explain these individual performances.

By: Francesco Papadia Topic: European Macroeconomics & Governance Date: June 18, 2019
Read article More on this topic More by this author

Blog Post

Uncertainty over output gap and structural-balance estimates remains elevated

The EU fiscal framework strongly relies on the structural budget balance indicator, which aims to measure the ‘underlying’ position of the budget. But this indicator is not observed, only estimations can be made. This post shows that estimates of the European Commission, the IMF, the OECD and national governments widely differ from each other and all estimates are subject to very large annual revisions. The EU should get rid of the fiscal rules that rely on structural balance estimates and use this opportunity to fundamentally reform its fiscal framework.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: June 17, 2019
Read article More on this topic More by this author

Blog Post

Developing resilient bail-in capital

Europe’s largest banks have made progress in issuing bail-inable securities that shelter taxpayers from bank failures. But the now-finalised revision of the bank resolution directive and a new policy of the SRB will make requirements to issue such securities more onerous for other banks. In order to strengthen banking-system resilience, EU capital-market regulation should facilitate exposures of long-term institutional investors.

By: Alexander Lehmann Topic: Finance & Financial Regulation Date: April 29, 2019
Read article Download PDF More by this author

External Publication

European Parliament

Taking stock of the Single Resolution Board: Banking union scrutiny

The Single Resolution Board (SRB) has had a somewhat difficult start but has been able to learn and adapt, and has gained stature following its first bank resolution decisions in 2017-18. It must continue to build up its capabilities, even as the European Union’s banking union and its policy regime for unviable banks continue to develop.

By: Nicolas Véron Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: April 18, 2019
Read article More on this topic More by this author

Opinion

Takeaways from Xi Jinping’s visit to France and Italy and ideas for the EU-China summit

The author appraises China's strategy towards Europe ahead of next month's EU-China summit.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: March 27, 2019
Read article More on this topic

Blog Post

The European Union must change its supervisory architecture to fight money laundering

Money laundering scandals at EU banks have become pervasive. The authors here detail the weaknesses the current AML architecture's fundamental weaknesses and propose a new framework.

By: Joshua Kirschenbaum and Nicolas Véron Topic: European Macroeconomics & Governance Date: February 26, 2019
Read article More on this topic

Blog Post

The higher yield on Italian government securities is becoming a burden for the real economy

Francesco Papadia and Inês Gonçalves Raposo have recently written on Italian fiscal policy and the increase in the spread between Italian (BTP) and German (Bund) government. Since then, two developments have taken place: one good, and one bad. This blog post reviews them.

By: Francesco Papadia and Inês Goncalves Raposo Topic: European Macroeconomics & Governance Date: February 5, 2019
Load more posts