January 4, 2017 / 11:30 AM / 8 months ago

More EU banks will be bailed out rather than in

A logo of Monte dei Paschi di Siena bank is seen on the ground in Siena, Italy, November 5, 2014.Giampiero Sposito

LONDON (Reuters Breakingviews) - Monte dei Paschi's rescue has hit Europe's new regime for rescuing banks where it hurts. The Italian state will fund three-quarters of MPS's 8.8 billion euro rescue, rather than winding it down. The rub is that it's hard to think of a bank that looks more like a candidate for resolution.

European authorities think they can square the circle. MPS is using a clause in Europe's Bank Recovery and Resolution Directive (BRRD) allowing governments to put capital into banks deemed solvent. The clause applies when a bank fails a stress test. This avenue also has a lower standard of "burden sharing" that only requires losses to be taken by junior creditors, not senior lenders and depositors.

Still, there's debate as to whether MPS qualifies for this clause. Jens Weidmann, head of Germany's Bundesbank, has raised two concerns: was the bailout necessary to remedy a "serious disturbance"? And would government capital be used to cover likely losses?

Unfortunately, it's hard to say who's right. The most basic solvency requirement, as judged by the European Central Bank, is that the bank must meet minimum capital standards, and only suffer losses in an adverse scenario. MPS ticks those boxes. Yet it's possible to be solvent today, but not robust. Netting off likely losses from an expected sale of bad loans would leave it with a common equity Tier 1 capital ratio below 7 percent, more than covered by its doubtful debt.

European rules are probably deliberately vague. The BRRD never defined what "serious disturbance" is or "likely losses in the near future". Linking solvency to stress tests makes sense, but increases risks if the tests are too generous.

The European Commission could justify a tougher approach. An MPS resolution might not have triggered financial chaos. But it would have difficult consequences. The Italian government would need to rescue healthier banks; anti-European sentiment in Italy may grow ahead of elections.

If MPS is a guide, European officials and regulators will prefer to use the precautionary recapitalisations route, rather than the resolution tool except in extreme cases. That means the bailout era is not permanently dead.

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