European Court of Justice ruling weighs on Italian banks – BBH

Research Team at BBH, notes that the European Court of Justice upheld the principle of making creditors bear the burden for investment in banks that sour before government funds can be used.   

Key Quotes                               

“Italian banks are particularly sensitive to the ruling, which cannot be appealed because the European Banking Authority and European Central Bank stress tests on July 29 are expected to show that some Italian banks are under-capitalized. 

The problem is that the private sector does not have much appetite and the government-facilitated Atlas fund does not appear to have sufficient resources after buying equity in two banks. Italian officials want to tread carefully around bailing in junior creditors. 

The European Court of Justice was clear:  "Burden-sharing by shareholders and subordinated creditors as a prerequisite for the authorization, by the commission, of state aid to a bank with a shortfall is not contrary to EU law."  There is an exception to the principle, and that is if bailing in "would endanger financial stability or lead to disproportionate results."  

Claiming extraordinary circumstances after the UK referendum seemed to be Italy's first push, but that was deftly blocked by Germany. 

Italian banks shares appeared to extend their earlier decline when the European Court of Justice decision was announced. 

Italian banks face three challenges: capitalization, bad loan, and profitability.   The government appears to be moving toward a recapitalization and a way to get the bad loans off the bank books.  The longer-run profitability of the banks may be too much to push for in this round.  If it were to mean higher unemployment, the government might not find, for example, that a campaign to reduce the number of bank branches to be particularly urgent.  

Addressing Italy's bank challenges is important in it own right, but is also important politically.  In three months, there is a referendum on the reform of the Senate. How Renzi deals with the banking issues, this summer may be more important for the outcome of the October referendum than the specific merits of the issue.”