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Does this amount to state aid?
While it has been technically dressed up as avoiding state aid, the reality seems to be that state aid is clearly involved, though the exact extent of it remains to be seen. The first point here is that the need for the state guarantee at all highlights that there are risks involved here which few market participants are willing to shoulder. If these could be priced and sold in the market then they would be. The second relevant question is around the pricing of the guarantees. The reports suggest it will based on the credit default swap (CDS) prices for similar securities. But as we know the securitisation market in the Europe is relatively small compared to say the US. Furthermore, these sorts of opaque securities are notoriously hard to price. This will be exacerbated by the fact that the loans themselves are hard to value individually, let alone when they are bundled up together. If the prices are simply based off of broader CDS then clearly it is equally unlikely to be accurate. So the notion that there is an easy market price out there on which to judge and base these guarantees seem to me to be a flawed one.
The final question is around the price at which the loans are transferred to the securitisation vehicle. While it has been widely noted that this system is different to bad banks used in Spain and Ireland, this specific problem is similar and is at the heart of all these interventions. Ultimately, the pricing of the original loan and the value at which it is transferred to the bad bank or the securitisation vehicle will determine the level of state aid involved. It also determines the usefulness of the whole exercise to the banks. If they are transferred at very low prices/values it would limit the state aid but then would impose significant book losses for many of the banks, eating into their capital and possibly making the exercise self-defeating. This then will be the crucial aspect to watch in the coming weeks and months. I don’t expect the level of state aid to be huge but to claim it is not involved seems to me to be a stretch.
What does it mean for the future of bad loan and bank resolution in Europe?
This is the bigger and more important question and why the plan has attracted so much interest. It is ultimately the first test of the Eurozone’s new bank bail-in rules which are meant to prevent undue state aid and keep the burden on investors rather than taxpayers. As explained above, it’s hard to see that it meets these requirements. The reason behind this is linked to the public outcry following the bailing-in of some retail investors in regional Italian banks back in November. The lesson many will draw is that, when the rules become politically inconvenient then they will be fudged. This adds to the confusion following the Portuguese decision to bail-in certain specific bondholders of Novo Bank (the good bank part of Banco Espirito Santo) over the Christmas period. Whenever a new banking issue arises it is hard for investors to know which approach will be taken, the exact problem the rules were meant to address.
Could the plan backfire?
Overall, the market seems to be underwhelmed by what is essentially a very limited plan to deal with some very large problems in the Italian banking sector. Additionally, while the plan tries to work within the state aid rules, it is hard to see that it successfully fits with the new legislation on investors not taxpayers bearing the burden. This sets a bad precedent going forward and adds to confusion which is already present given the multitude of ways in which bank resolution issues have been dealt with over the past year in countries such as Portugal and Austria. This all suggests the Italian government should quickly come forward with some further reforms to help address the banking sector issue. But it also drives home the importance of it moving swiftly ahead with its broader economic and institutional reforms. Without a combination of these reforms the outlook for the Italian banking sector and the country more generally will continue to be mixed.