EU Bailouts

A Pragmatic Rescue

The entrance of Monte dei Paschi di Siena bank's headquarters in Siena, Italy, July 1, 2016. REUTERS/Stefano Rellandini/File Photo
Monte dei Paschi di Siena is one of the Italian banks most in trouble. The E.U. needs to allow them to be rescued.
  • Why it matters

    Why it matters

    Sticking to the new rules governing bank bailouts in the European Union could wind up causing more damage than it avoids, the author argues.

  • Facts


    • Since January, the European Union has introduced rules requiring banks to take haircuts from their creditors and even depositors before turning to taxpayers.
    • Italy’s banking system faces a major capital shortfall of as much as €40 billion and the government is pushing for a taxpayer bailout.
    • European banking stocks have plummeted across the board since Britain’s June 23 referendum on E.U. membership.
  • Audio


  • Pdf

The first new banking emergency came along much sooner than we all would have wanted.

In Europe, new rules for rescuing banks in the aftermath of the 2008 financial crisis have only been in place since the beginning of January. The noble goal of the new regime: Never again should taxpayers be called upon to prevent a financial institution from collapsing.

Still, all participants surely wouldn’t have wished for these strict new rules to be tested so quickly. The first emergency is sadly already upon us.

Italy’s banks have amassed a huge mountain of bad loans that they have to somehow shed. Many desperately need new capital, especially the crisis-plagued Monte dei Paschi. Altogether, it could take as much as €40 billion to put the Italian financial system back on a firm footing.

Now comes the crucial question: At the first sign of crisis, should the new E.U. rules be put on hold and the Italian state allowed to support its banks with more or less direct aid? Or should the European Commission stand firm in order to avoid setting a precedent?

The rules allow for exceptions in emergencies. Italy's banks are no longer far from falling into a genuine emergency.

The answer may seem profoundly dissatisfying in regulatory and even moral terms. But in cases of doubt, regulators and E.U. politicians should opt for the pragmatic solution. They should allow Italy to put an end to the incipient banking crisis as quickly as possible.

Lessons learned from the 2008 financial crisis recommend such a policy, as does the danger of political and economic contagion. After the Brexit vote, Europe simply cannot allow itself any more trouble spots.

What do the controversial new regulations look like in detail? Since the start of the year, there is an E.U. rule that not only the owners, but also the creditors of a bank must participate financially in its rescue. Eight percent of the entire liabilities of a bank must be used up before the state is allowed to intervene.

But precisely this requirement is now causing investors to pull out of Italy’s banks in droves. Hence Prime Minister Matteo Rienzi is pressuring the European Union to soften the rules.

The first good argument for giving in to this pressure: The rules allow for exceptions in emergencies. Italy’s banks are no longer far from falling into a genuine emergency.

The second argument: The new rules were designed for stable banking systems, but the Italian banking system was never really stable. Ever since the financial crisis, it has scraped through from one precarious situation to the next. The banks should have been recapitalized long ago and the balance sheets cleaned up.

The third argument for acceding to Italy’s demand is provided by a look back to the time right after the failure of U.S. investment bank Lehman Brothers.

In 2008, Europe refused to deviate from its regulations and for a long time hesitated to grant governmental help to stricken banks, in order not to create false incentives. That was morally correct: It isn’t acceptable for banks’ profits to go to private individuals but their losses to be borne by society.

If even smaller savers were actually compelled to share in the costs of a bank restructuring, that could have ugly consequences for Italy politically.

The United States, however, went down another road: First the banks were solidly recapitalized, if necessary even against their will; only afterwards did monitors and politicians set about formulating new rules to create a financial system that was as safe from crises as possible. The result: America’s banks are healthy and have long been once again well-positioned. They can support economic growth, while European financial institutions are still struggling to rebuild capital, strategy and trust.

That brings us to the fourth argument: The danger of contagion. Throughout Europe, bank stocks are plummeting. The causes lie in the shock after the Brexit vote, the fear of a significant slowdown in the world economy and the problems of Italian financial institutions, but also investors’ uncertainty because of the new E.U. rules regarding liability.

Already in February, distrust of the new rules led to a steep fall in bank values on the stock exchanges. While it could be argued that investors should have been prepared for the rules changing, this doesn’t change the fact that the crisis of trust on the exchanges could quickly turn into a genuine banking crisis.

But even this crisis wouldn’t be as menacing as the political dangers that could arise if Italy were required to adhere precisely and literally to the new E.U. rules. Five billion euro in subordinated debt is under threat at the most severely threatened bank Monte dei Paschi alone; the majority of those liabilities are in the hands of private investors.

If even smaller savers were actually compelled to share in the costs of a bank restructuring, that could have ugly consequences for Italy politically. The country faces a constitutional referendum scheduled for October. And we are currently learning through Brexit what social costs the wrong result in a popular referendum can have.


To contact the author:

We hope you enjoyed this article

Make sure to sign up for our free newsletters too!