The European Court of Justice may have rescued Italy’s banks

July 19, 2016


Italy has been trying, with no success, to get the ECB and European banking authorities to allow it to rescue its banks with a bail out package that may be as big as €40 billion of public money. Unlike banks in most other European countries, Italy’s got sick the old fashioned way by lending to businesses in its own market, and then having the loans go bad because of business failures caused by Italy’s never ending stagnation. Italy’s economy is still slightly smaller than it was in 2000.

New Euronzone-wide banking rules took effect in January. They require bank bail-ins as the remedy for sick banks, with only narrow exceptions. “Bail-in” means wiping out shareholders, and then wiping out bondholders and converting bondholders to equity holders to the degree that you now have a bank with a decent equity cushion. So under the new EU rules, if a bank gets into trouble, before it can get state funding it must convert some of its bonds to almost worthless shares, thus wiping out the value of the bonds owned by third parties.

That might sound sensible, except in Italy, many banks effectively cheated depositors by persuading them to buy bonds that are junior enough to put them first in line in a bail-in, by telling them those bonds were just as good as deposits. So bail-ins would hurt and potentially wipe out a lots of ordinary savers. That would not only damage the economy in a serious way, but it would also create political havoc. Premier Matteo Renzi is already at risk of losing to Beppe Grillo’s Five Star movement in elections this fall. Bail-ins would seal his fate. Five Star has vowed a referendum on exiting the Eurozone. Given that the currency union has become an economic straight jacket for Italy, a pro exit win in a referendum is seen being a distinct possibility. One would think the foregoing would motivate the Eurocrats to cut Italy some slack, and Renzi has made several cases as to why Italy should get a waiver but has been meeting much resistance from the Germans who argue that rules are rules..

But has the European Court of Justice may have given Italy a reprieve having just ruled that EU member states are not obliged to make shareholders and junior creditors pay before intervening to rescue a bank.

EU rules imposing losses on bank creditors before a bank bailout were considered legal by the Luxembourg-based European Court of Justice in its ruling over a Slovenian banking rescue.

However, the rules are not binding on member states, the court said in its ruling that slightly limits the European Commission’s antitrust powers amid talks for an Italian banking bailout. The court said that burden-sharing by shareholders and subordinated debt holders was not a precondition for granting state aid to a troubled lender.

German Finance Minister Wolfgang Schaeuble has warned against a discussion about support for Italian banks before the European Central Bank publishes stress test results on July 29, although many investors want to see a solution before then.

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