9/1/19: Banca Carige & the Promise of Euro Banks Insolvency Resolution Regime

Italy has been the testing ground for the European regulatory framework for resolution of insolvent banks for several years, running. In all past sagas, the framework has been shown to fall short of protecting the taxpayers from the risk contagion loops that dominated the banking sector insolvency resolution regimes during the Global Financial Crisis. And the latest problem bank, Carige, is no exception.

Per latest reports (https://www.ft.com/content/b9fe3384-1427-11e9-a581-4ff78404524e) the Italian Government is pushing toward nationalization of the troubled lender in need of at least EUR400 million in fresh capital - capital it can't raise in the markets. The Government is also set to guarantee new bonds sold by Carige.

Carige assets of ca EUR25 billion are set against current capitalization of just EUR84 million. Per V-Lab data, Banca Carige is suffering from a massive spike in liquidity risk, with illiquidity index (a measure of liquidity risk) spiking to its highest levels in more than 21 years:

In late December, the ECB has taken the unprecedented step of placing Banca Carige in temporary administration, with administrators given three-month mandate to reduce balance sheet risks and arrange sale/merger/takeover of the bank. As a part of this work, the administrators are trying to review the Italian Government guarantee (issued in December) that led to the Italian deposits guarantee fund (FITD) purchasing EUR320 million of Carige's bonds.  In a notable development, the purchased bonds are potentially convertible into equity in an event of Carige's capital levels falling below regulatory threshold. In other words, these are CoCo-type bonds, implying the state fund is carrying the entire risk of Carige's future capital breaches. Beyond this, there are on-going talks with the Government on the possible SGA SpA (state-owned bad assets fund) purchase of some of the Banca Carige's non-performing assets. As an important aside, the existent bondholders in Carige are not subject to the bail-in rules the EU has put forward as the core measure for reforming banking sector insolvency regime.

These guarantees, buy-ins into Carige's bonds, lack of bondholders bail-in, and potential purchases of the bank's troubled loans constitute a de facto bailout of the bank using sovereign (taxpayers) funds. In other words, the European banking insolvency regime core promise - of shielding taxpayers from the costs of banks bailouts - is simply an empty one.

17/2/16: Another Germanic policy straightjacket

My comment on the Germany's "Sages" proposal for sovereign bonds bail-ins rule for Portugal's Expresso: http://expresso.sapo.pt/economia/2016-02-16-Risco-de-um-ataque-especulativo-as-dividas-dos-perifericos.

In English unedited:

The proposed 'sovereign bail-in' mechanism represents another dysfunctional response to the sovereign debt crisis in the Euro area. The mechanism de facto exposes sovereigns locked in a currency union to the full extent of monetary and fiscal risks that reside outside their control, while reinforcing the risks arising from their inability to control their own monetary policies.

Under the current system, a run on the sovereign debt in the markets for any individual state can be backstopped via ESM as a lender of last resort. In a normally functioning currency union, such a run can be backstopped also via monetary policy and fiscal mechanisms.

In contrast, within the proposed bail-in system, both the ESM and the monetary policy become unavailable when it comes to securing a backstop against a market shock. The full extent of a run on Government bond for a member state will befall the fiscal authorities of the member state - aka the taxpayers who will end up paying for bonds bail-ins through higher yields of Government debt and fiscal squeeze on expenditure and taxation.

In theory, a bail-in mechanism for sovereign debt can be implemented in the presence of three key conditions:

• firstly, the implementing country must have control over its own monetary policy; 
• secondly, the implementing country must have benign debt levels and low reliance on concentrated holdings of its debt, especially in the systemically important institutions (for example by a handful of larger banks); and 
• thirdly, the implementing country must have strong fiscal balancesheet to absorb shocks of risk-repricing during the period of bail-in rule introduction. 

None of these conditions are satisfied by the Euro 'periphery' states today, nor are likely to be satisfied by them in the foreseeable future. At least two of the three necessary conditions are not satisfied by the vast majority of the Euro area states at the moment and are also unlikely to be satisfied by them in the foreseeable future.

In a sense, we are witnessing another attempt to put Euro area into a Germanic policy straightjacket in a hope that this time around, the outcome will be different and that bail-ins rules will fix the unresolvable dilemmas inherent in the Euro design. It is a vain hope and a futile exercise that is creating more risks in exchange for no tangible gain.