Big European Banks Try to Block Contagion from Italian Banking Crisis (Before it Sinks them)

These big banks have every reason to try keeping Italian banks afloat.

By Don Quijones, Spain & Mexico, editor at WOLF STREET.

Europe has plenty of reasons to be worried these days, but none more so than the seemingly terminal decline of the old continent’s banking system. So fragile are Europe’s banks that they can’t even get through an ECB stress test — whose primary purpose is to restore confidence in Europe’s banking system, by ignoring two of the most insolvent national banking sectors (Greece and Portugal) as well as the main source of stress (negative interest rates) — without sparking a panicked sell-off.

Before the test, UK-based Barclays predicted that any bank found to have a core capital ratio of less than 7.5% would come under pressure. There was no shortage of candidates, including, ironically, Barclays itself, which made it through the stress scenario with a core capital ratio of just 7.3%. The bank’s shares have fallen by about 5% since Monday.

Barclays is no small-time institution; it is the UK’s second largest bank by assets and a member of the select club of global systemically important financial institutions: it’s too big to fail. So, too, is Deutsche Bank, which in the test was the 10th riskiest out of 51 on core capital and whose shares have tumbled 60% since May. Credit Suisse, another systemically important institution, has lost close to two-thirds of its market value in the last year while Italy’s Unicredit, another too-big-to-failer, has shed roughly the same amount since the start of 2016.

The market capitalization of Deutsche and Credit Suisse has shrunk so much that they just suffered the ignominy of being ejected from the Euro Stoxx 50, a stock index designed by Deutsche Börse Group that comprises Europe’s 50 largest and most liquid stocks.

Meanwhile, things have gotten so bad at Italy’s third biggest bank, Monte dei Paschi, that it was just removed from the Euro Stoxx 600 after getting top honors in the ECB’s stress test. Under a stress scenario its Common Equity Tier 1 (CET1) slumps to negative 2.44%. In other words, the world’s oldest bank is not just insolvent in an adverse scenario; it’s insolvent right now.

This realization prompted yet another stampede out of Italy’s banking equities. On Thursday, Italy’s government responded by issuing blanket denials in an almost slapstick attempt at damage control.

Italy’s banks are “not in crisis” and pose “no systemic threat”, the country’s EconMin, Pier Carlo Padoan, breezily informed the country’s parliament.

In an interview with Politico, Bank of Italy Governor Ignazio Visco asserted that most of Italy’s largest financial institutions are “robust” and able to withstand economic shocks:

“Overall, the results (of the stress test) provide a fair picture of the current state of affairs of Italian banks: many institutions with robust fundamentals, and a few, well identified cases of serious but manageable weakness, which must be tackled and solved, as required by bank supervisors.”

Today, Visco told the Italian media that it is “wise to be prepared” to use taxpayers (state aid, as it’s called) to bail out Italian banks, “regardless of Monte dei Paschi,” for which state aid is already in the works, “though it does not mean it will be necessary.” So state aid for other Italian banks too, not just Monte dei Paschi?

Visco’s comments compound investor fears that the the last-ditch rescue plan with government guarantees that JP Morgan hastily assembled with Italian lender Mediobanca on Friday afternoon will be yet another case of “too little, too late.” News of the plan did briefly staunch the outflows. It even raised the bank’s share price by a few cents. But by Monday morning investors were once again fleeing the ship.

The first part of JP Morgan’s plan entails the resolution of bad debts, which would be packaged into a special vehicle and sold, sent or concealed elsewhere. The second part is reportedly a capital injection of €5 billion. The participants in the capital expansion will include the Goldman Sachs, Citigroup, Banco Santander, Credit Suisse, Deutsche Bank and Bank of America Merrill Lynch.

Many of these global lenders dominate the advisory and intermediary services provided to Italian banks and companies, in particular in the areas of corporate finance and investment banking. Three of them have already had importantly dealings with Monte dei Paschi: Deutsche in the infamous Santorini derivatives trade that was seemingly used to distort earnings and which ended up costing the Italian bank billions in losses (oh, and which the Bank of Italy, under Draghi’s tutelage, apparently knew about yet sat on its hands); JP Morgan, which arranged a special purchase vehicle for the bank; and Goldman, which issued a triple-recourse bond for Monte dei Paschi last year.

These three banks, and all other big banks in Europe and probably elsewhere, have every reason — primarily self-preservation — to want to keep Italy’s financial system afloat.

This is not the first time that bulge-bracket banks have clubbed together to “help out” a struggling European bank. Less than two months ago, five of the same banks that are now helping to “save” Monte dei Paschi — Goldman, Citi, Santander, Deutsche and Credit Suisse — were among 10 global lenders that came to Spain’s Banco Popular’s aid at the eleventh hour by underwriting its €2.5 billion rights issue. Despite the capital expansion, Popular was one of the worst performers in the ECB’s stress test and is expected to have racked up losses of at least €2.5 billion by the end of this year.

The problems in Italy are of a much greater magnitude than those in Spain, whose banking system has at least been partially recapitalized since the last crisis. Indeed, the biggest banks on both sides of the continent are so worried about the potential threat a banking collapse in Italy could pose to their own existence that they’re willing to put their money where their mouth is — though doubts are already emerging about the veracity of the €5-billion figure. In the end, however much they pool, it’s unlikely to be enough to steady Italy’s financial system, especially given that Monte dei Paschi is just one of a host of banks that will end up needing intensive intervention of one sort or another, including too-big-to-fail Unicredit. By Don Quijones, Raging Bull-Shit.

So who’s really going to bail out the banks? Read…  Did Germany Just Blink?

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  20 comments for “Big European Banks Try to Block Contagion from Italian Banking Crisis (Before it Sinks them)

  1. wholy1 says:

    It’s the derivatives “musical chairs” contest: which bankster causes the derivative domino cascade.

  2. Colin says:

    Is there any way the banks can solve their problems without any pain? If it causes a serious global crisis, how bad does the crisis get? Is a Depression possible?

    • Chicken says:

      Perhaps you misunderstand, this isn’t a problem caused by or to be solved by banks, they are the victims of society thus must be compensated.

      • Chip Javert says:

        Yea, sure; the banks didn’t make any of those bad loans…the banks aren’t really rolling over the vampire debt…the banks have no control – their managers are highly compensated out of shareholder kindness. Who knew?

        Gimme one of those Italian bank manager jobs RIGHT NOW! I’m fully qualified (i.e. incompetent), and, heck, I don’t even speak the language.

    • Thomas Malthus says:

      When this turns over it will be far worse than a replay of the Great Depression.

  3. Chicken says:

    The reality is becoming clear central banks deserve a medal of accommodation from society for working all of this out and sparing them from the pain of depression…

  4. alexaisback says:

    Britain obviously picked a great exit in Brexit.
    And To think of the threat that the banksters will all leave London for elsewhere – this is obviously ridiculous given the shape of the rest of Europe. Surely The London Whores will stay in London and watch.
    EG: Would anyone dare go to France – the lunacy.
    Ridiculous French work ethic and ethics.
    . So ridiculous.

  5. d'Cynic says:

    I am not sure if I understand this stress test thing correctly.
    ECB stress tests Barclays based in UK, or Credit Suisse based in Switzerland which are not part of Eurozone, and so not the responsibility of the ECB.
    Also includes other banks that have major operations outside of Europe.
    Or is it just for show?

    • Wolf Richter says:

      The EBA did the testing. That’s the European Banking Authority, headquartered in London, one of the compromises made to get the UK on board.

      Last year, the ECB was also put in charge of regulating the largest banks in the EU. The EBA’s stress tests were done in cooperation with the ECB, according to my understanding. The biggest EU banks were tested. Credit Suisse was not part of the test.

      But Credit Suisse is one of the biggest banks in Europe (the continent) and cannot be ignored in an article about European banks. Hence DQ included it when discussing market cap, etc. And it’s part of the group that might prop up the Italian banks. But he didn’t say that Credit Suisse was stress tested.

      The EBA has no teeth as regulator, but the ECB has several teeth.

    • Thomas Malthus says:

      Yes of course — these banks are mostly insolvent…. and because the financial system is interconnected — even solvent banks are insolvent.

      It’s a giant wall of dominoes.

  6. dave says:

    I fail to understand if a bank can just sell its bad loans or hide them or do whatever they can to make them disappear. Why not? Act like they never existed and go about uour business. Apparently no one will miss the money and all those good people wont have to worry about paying the money back. Spend that money somewhere else. Financial engineering. Really lets look at what happening around the world. Governments spend money they dont have buy a bunch of investments inflate prices and when it or if it crashecrashes they will just write it off like nothing happened cause its not their money. Oh well. I say. QE infinity. A world with no interest payments.

    • MC says:

      That’s what Italian and German banks are adept at doing. It works… until it doesn’t.

      In times of fat cows NPL’s can be “swept under the rug” for the simple reason the bank has so many other sources of cash to pay both dividends to shareholders and interest on bonds. Core capital is good because people and firm make money and put that money in the bank: it’s hard cold cash.
      But when lean cows arrive it becomes harder and harder to find sources of cash. Shareholders are the first to get hit: they see dividends evaporate first and with them equity value. Bondholders start looking nervously over their shoulders: after Banca Etruria defaulted on its obligations late last year the idea that bonds issued by euro-area banks will pay interests no matter what has flown out of the window. The Italian government will make bondholders whole one way or the other (political considerations) but it’s taking too long and the damage’s done.

      To make matters worse, ZIRP’s first and now NIRP’s are making it harder than ever before for banks to make money and hence hide that mass of NPL’s: banks have long made the bulk of their profits from the spread between central bank interest rates and the interests they charge customers for loans. Sadly, the lower central bank interest rates, the more yield is compressed: when all is said and done, European banks make no money from traditional cash cows such as mortgages. That’s why they are piling into consumer credit, derivatives and other dangerous assets. These assets have their place on a bank’s books but cannot be the main profit turner, as Deutsche Bank, Credit Suisse and Barclay’s are learning.

      Chinese banks are different. Chinese regulators have the magical ability to simply order their banks to “evergreen” NPL’s, an ability much envied by their Western and Japanese colleagues who have to perform accounting gymnastics and regulatory acrobatics to hide NPL’s from view.
      Of course this ability comes at a cost: Chinese banks are effectively cut off from First World markets and for good reasons. Nobody has a clue about how their accounting truly works, how they operate, how solid they truly are, where the Chinese State stops and the bank begins etc.
      Our own banks hide much from depositors and investors with the regulators’ blessings, but Chinese banks are in a league of their own.

      Before thinking Chinese banks are immune to everything due to the wonders of central planning, I need to remind you that NPL’s destroyed the State-owned banking system of South Korea.
      By the time of the Asian crisis, the big Korean chaebol, led by Daewoo, had accumulated debt, often in foreign currency, for over two decades. Korean banks owned much of this debt and due to the Park Era accords between the chaebol and the State, very often made only token repayments on it… while the banks simply “evergreened” these loans.
      During the tumultous growth of the Korean economy during the late 80’s and early 90’s this was hailed as a perfect system, yet again a proof of the superiority of central planning.
      Where have I heard that recently?

    • Thomas Malthus says:

      When you are facing the collapse of civilization – you do ‘whatever it takes’

  7. unit472 says:

    This rescue of BMPS is redolent of the ESM and EFSF deals where everybody, including the weakest links, join together to issue AAA bonds even though most of the guarantors are not , themselves, AAA nations.

    Instead of a Charles Atlas holding a massive barbell over his head you have a dozen 97 pound weaklings all joining together to lift the same weight and pretending that is strength. When one or two of the weaklings buckle under the strain the barbell will come crashing down and take out the rest of the weaklings.

    • MC says:

      Don’t worry: our collective head will take the barbell right between the eyes “for the common good” and to save these weaklings pain.
      Like we’ve been doing since 2008, when we started being not so stealthily taxed through financial repression to insure the debt-fueled binge could go on indefinitely.

    • nhz says:

      In the same spirit, it’s interesting that many EU homeowners enjoyed lower credit rates (for mortgages) for many years than their own governments. This was very obvious in some ClubMed countries like Spain during the last 10 years, and even now that is still true in several countries.

      It doesn’t make sense (maybe it does if one assumes that people who don’t need a mortgage to buy a home or those who are renting are a big financial liability risk for the country …).

  8. Yoshua says:

    The QE’s, ZIRP, NIRP and NPL’s are signs that the economies that banks service are vibrant and strong ?

    • Chicken says:

      Perhaps that’s what they want people to think, there might be another explanation entirely?

  9. nhz says:

    I doubt the problems in Italy are of much greater magnitude than those in Spain. The problems in Italy are more acute for sure, the problems in Spain have been swept under the rug thanks to ECB ZIRP/NIRP policy but they are not solved.

    When rates go up again the problems in Spain will prove to be even bigger than they were. A huge chunk of the population depends on continuation of ZIRP/NIRP to survive, and the books of the Spanish banks will look very different when rates go back to normal values. Spanish Euribor-tied mortgages where a major reason for the ECB to start it euro-trashing policies years ago.

    Of course the same goes for several other EU countries with a ‘solid’ financial position, e.g. the Netherlands.

  10. Dwain Dibley says:

    All of this is to maintain the illusion that bank debt is money, and it can’t be “fixed” by maintaining a capital ratio, which only indicates a bank’s ability to go further into debt using capital that has a value generated by previous debt creation.

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