Italy's bank troubles test ECB's mettle

MILAN (Reuters) - The European Central Bank is trying to strongarm Italian banks into cleaning up their balance sheets, a year and a half after they fared the worst of all euro zone lenders in its first stress tests as overarching supervisor.

A woman walks in front of the Banca Popolare di Milano (BPM) bank in downtown Milan, Italy, in this January 29, 2016 file photo. REUTERS/Alessandro Garofalo/Files

The banks have made scant progress on requested reforms, threatening to undermine a fragile recovery in the bloc’s third largest economy. They argue the ECB’s demands are unrealistic and delay the very consolidation the sector needs.

The standoff poses one of the biggest challenges to Europe’s central bank since it became the euro zone single banking regulator in November 2014. After Greek banks, Italian ones are now taking up most of its time.

Banks like Carige CRGI.MI and Monte dei Paschi di Siena BMPS.MI have their liquidity monitored daily and the ECB, working in teams with Italy's central bank, is firing off missives telling lenders to raise capital, find a buyer and sell off bad loans.

“They phone, they e-mail and they come down to see us,” said a source at one Italian bank, who declined to be named due to the sensitivity of the issue.

“They are a constant presence. For one reason or the other there is always an inspection - I’d say they are here two months out of three.”

Letters to Veneto Banca and Banca Popolare di Vicenza, which must raise a combined 2.75 billion euros in cash and list on the market to meet ECB demands, threaten all the measures allowed by the EU banking resolution directive -- including the last resort of the ECB removing top executives and taking over management.

A crucial test of the strategy is a much-anticipated merger between Banca Popolare di Milano PMII.MI and Banco Popolare BAPO.MI that would be Italy's first tie-up since the ECB took on supervision.


The boards of BPM and Banco Popolare are meeting this week and sources close to the matter say Banco Popolare is considering a cash call of up to 1 billion euros as part of measures sought by the ECB to clear the merger.

Any deal would still need the blessing of both banks’ shareholders, including powerful unions who fear a tie-up will lead to job cuts.

Bankers close to the talks say the ECB’s conditions for approving the combination have been so stringent that after months of negotiations, the two banks considered abandoning the deal, which would create Italy’s third biggest bank.

“If this merger falls through, the ECB will have to take responsibility for this,” said a frustrated adviser for one of the banks. “It’s like the doctor killing the patient.”

Danielle Nouy, the ECB’s bank supervisory chief, said on Tuesday the merged bank had to be strong from the start.

“We are working very hard with our Italian colleagues to make sure that we put the adequate requirements, no more than is needed but no less, either,” she told the European parliament.

The ECB is demanding a leaner structure and a business plan for the new group within a month: the original deal outline included a 19-member board, two headquarters, no cash call and Popolare di Milano keeping its autonomy and a separate board for six years.

Prime Minister Matteo Renzi -- who last year rammed through a decree intended to encourage banking mergers -- weighed in on Friday to put pressure on the lenders to reach an agreement.

A sell-off in Italian banking stocks - some have lost more than half their value so far this year - and a flight of deposits from banks seen as more vulnerable, means the government feels time is running out.

“2016 is the year when Italy must sort out its banking problems once and for all,” Renzi said.


Analysts say the ECB, which is headed by former Bank of Italy chief Mario Draghi, wants to establish itself as a credible institution, ensuring Europe’s banking industry is on a sound footing and taking laggards to task.

“The regulator is being extra cautious and particularly severe and active when it comes to Italy but the situation warrants it,” said Andrea Resti, an adviser to the European Parliament on banking supervision.

After a three-year recession, Italy’s banks are saddled with 360 billion euros ($405 billion) of bad loans - one third of the European total and equivalent to one fifth of Italy’s output.

Banks are reluctant to sell soured debts quickly, fearing that would blow a hole in their accounts and force them to raise cash in rough markets.

One reason for the sector’s fragility is the fragmented financial industry with 650 banks, most of which are tiny lenders with patronage ties to local communities. “It’s not that banks in other countries don’t have problems, but in Italy it’s more widespread, because you have lots of small banks that do not have the shock absorption capacity you find in bigger banks,” said Nicolas Veron, a financial services expert at think-tank Bruegel in Brussels. “A third of the banks that failed the ECB tests were Italian, but since then not much has happened.”


The unresolved problems of Italy’s banking sector also serve as a reminder of the scars left by the euro zone debt crisis.

The banks’ large holdings of government bonds plummeted in value as the cost of servicing Italy’s debt, the world’s fourth largest, soared at the height of the crisis.

Rome said then it did not need a Spanish-style, EU-funded bailout for its banks, but only the ECB’s pledge to save the euro and its cheap long-term loans halted the vicious circle of sovereign risks sinking the country’s lenders.

Now the government’s hands are tied, because under tougher European rules that came into force this year any rescue of weaker banks would wipe out shareholders and impose losses on creditors and perhaps even large depositors.

Italians got a bitter foretaste of the new regime when the government salvaged four tiny banks in November and 12,000 retail bond holders lost their savings.

Bankers under the microscope say ECB supervisors have uneasy relations with the Bank of Italy, which also declined to comment for this article.

“There is an atmosphere of mistrust and they think Italian banks have been let off the hook for too long by the national regulator,” said a senior investment banker involved in the merger negotiations between the two cooperative banks.

“The ECB is really giving us a hard time.”

($1 = 0.8895 euros)

additional reporting by Paola Arosio in Milan, Stefano Bernabei in Rome and Francesco Canepa in Frankfurt; editing by Philippa Fletcher