FRANKFURT (Reuters) - Some senior regulators are privately raising doubts over whether politically unpopular European rules seeking to shield taxpayers from bank bailouts will ever be enforced as intended.
"Bail-ins" were trumpeted as the centerpiece of Europe's response to the financial crisis, but some of the people who will have to apply them are now questioning in private whether they will be used following the Italian government's rescue of the troubled Monte dei Paschi di Siena (BMPS.MI).
The bail-in rules demand that private investors must suffer some losses before public money is used to rescue a bank.
But in the case of Monte dei Paschi, Italy used an exception built into the new rules to avoid a bail-in of senior bond and savings account holders, thereby setting a dangerous precedent for other crisis-struck lenders in Italy and beyond.
"A bail-in of savers would cause a revolt in Italy and could bring down the whole euro project by boosting anti-euro parties," one source told Reuters.
Imposing losses on creditors, who sometimes include small savers, is economically damaging and politically painful at a time when public resentment towards the European Union is running high and elections loom in key countries.
Against this backdrop, banks are struggling to raise the capital they need to deal with unpaid loans accumulated during the economic downturn.
The head of the German banking association, Michael Kemmer, has said Rome's approval of a "precautionary recapitalization" of Monte dei Paschi just before Christmas, after the bank failed to find enough private investors to back its capital increase, puts regulators' credibility at risk.
Ratings agency Moody's said the rescue, which is awaiting European Commission approval, "raises questions regarding the European authorities' commitment to follow strictly the ... bail-in provisions to resolve troubled banks".
"The SRB is the most useless institution in Europe because no-one dares to use it at the moment," one European regulator said of the euro zone's Single Resolution Board, which is in charge of bail-ins.
But its head Elke Koenig said last week she had no concerns about the application of the directive, while an EC spokesperson said the rules "apply on a case-by-case basis to a specific bank in its specific circumstances".
The SRB's Koenig may find her faith is put to the test soon, with a number of smaller Italian banks still trying to raise capital and Italy's top lender, UniCredit in the process of raising 13 billion euro ($14 billion) through a cash call.
"A first round of losses must be absorbed by the state if the banking system is to be rescued," Gennaro Pucci, head of investment firm PVE Capital, said, estimating around 100 billion euros in public money may be needed.
Cleaning up balance sheets has been a key objective of the European Central Bank, which wants to bring down the amount of bad loans to free up resources for fresh lending.
This risks backfiring, however, if banks try to sell more non-performing loans (NPLs) and shares than investors are prepared to buy.
"In the end, the ECB’s effort to clean up banks' balance sheets too quickly may be counterproductive," Marco Troiano, a director at ratings agency Scope, said.
"At present, there's just not enough appetite out there to buy the NPLs and subscribe capital increases on a wide scale."
Even in euro zone countries where bailouts took place before the new rules, some banks are still not out of the woods.
Portugal's Novo Banco, the so called 'good bank' carved out of the collapsed Banco Espirito Santo, and Germany's HSH Nordbank may need further state help if they can't find buyers.
U.S. hedge fund Lone Star, the top bidder for government-owned Novo Banco, has asked for a state guarantee on its investment, prompting calls from two leftist parties that prop up Portugal's minority government that the firm be nationalized instead.
Bailed out during the crisis, HSH Nordbank has until February 2018 to find a buyer or be wound down.
The bank's management says it has a good chance of finding an investor. But some question whether it would be allowed to go under even it did not manage to do so.
Additional reporting by Francesco Guarascio in Brussels; Editing by Alexander Smith