The Italian banking system now poses the biggest risk to the financial security of the eurozone and its most venerable institution is at the heart of the problem. Here is what you need to know.
Why is Monte dei Paschi di Siena in trouble?
The world’s oldest bank has become the focus of the market’s concerns about the health of the Italian banking sector, which is weighed down by €360bn (£305bn) of bad debts. Monte dei Paschi was the weakest performer in the annual health checks performed on 51 EU banks in July. The European Banking Authority found its capital base would be wiped out if the global economy and financial markets came under strain and it was instructed to take preemptive action to bolster its financial strength.
Why did it need an extension from the European Central Bank?
The European Central Bank issued MPS with a deadline of the end of the year to implement a plan to make it more resilient. The Wall Street bank JP Morgan has been leading efforts to revive the bank by spinning out problem loans and raising €5bn from investors. It was always going to be a race against time, especially as the sum being raised is almost 10 times its current stock market value.
So what’s gone wrong?
The result of the Italian referendum on Sunday made the task even harder. The resignation of Matteo Renzi – credited with efforts to clean up Italy’s banks – has caused fresh political uncertainty. Investors in Italy are accustomed to upheaval as the country has had more than 60 governments since the second world war. But, the latest bout of turbulence comes at a crucial juncture, just when bankers to MPS was trying to convince major investors to stump up billions of euros.
What are the consequences for MPS if it fails?
Once again, the clock is ticking towards the year-end deadline imposed by the ECB. Time is short if private investors - notably Qatar’s sovereign wealth fund - are to be convinced to buy shares in the Italian bank. If the private sector solution fails, the expectation is that the Italian government will orchestrate a “precautionary recapitalisation” – a state-supported cash injection for the bank.
What would the Italian government’s involvement entail?
Under new EU rules, government funds cannot inject money into banks if bond holders have not taken losses first. The move is intended to avoid a re-run of the tax payer bailouts of 2008 but was targeted at major City investors. In Italy, though, small investors could get hit. Some €2.1bn of MPS bonds are owned by retail investors – people, rather than financial institutions – who face taking losses. Depending on how the recapitalisation is structured, bond holders might be able to avoid these losses.
What are the repercussions?
It is the first major test of the EU’s new rules for bank rescues. If Italy is allowed to deviate from them, it could undermine the whole system. But failing to find a solution to MPS could further destabilise the Italian banking system, especially at a time when rival Unicredit is thought to be preparing to raise €12bn.
