Thorsten Beck is the Director of the Florence School of Banking and Finance
The never-ending saga of Monte dei Paschi di Siena is a mirror of where Europe’s banks, regulators and politicians have gone wrong over the past 20 years: a rapid expansion before 2008, followed by mounting losses, hidden from auditors and regulators; a government bail-out in 2013, which did not help turn things around and nationalisation in 2017. At the core of this drawn-out failure of MPS has been too close a relationship between politicians and bankers, which has prevented early and effective intervention. The rapid if not aggressive expansion of MPS in the years leading up to the Global Financial Crisis of 2008 set the stage for its subsequent trouble. However, it was not alone: Fortis in Belgium and the British Royal Bank of Scotland similarly suffered after uncontrolled growth. Unlike these last two banks, however, MPS made it through the crisis without outright failure or nationalisation, though with government help of nearly €2 billion in 2009. It was not until 2013 that it became clear how it had ‘survived’ the crisis – by hiding losses through complex derivative contracts not reported to auditors nor supervisors. This ultimately required a bailout by the Italian government. In spite of the bailout, problems were not addressed aggressively enough. Instead, the can was kicked down the road. Again, MPS was not the only and not the last bank in Europe that had managed to hide its losses; the financial health assessment of the largest financial institutions across Europe (Comprehensive Assessment) in 2014 showed significant variation in asset quality and resilience to stress.
Tellingly, MPS’ losses were related to its €24 billion portfolio of Italian sovereign bond holdings, another constant in European banking troubles. Economists have dubbed it doom-loop: overindebted governments and failing banks holding bonds issued by their own governments have been at the core of the Eurodebt crisis in the last decade. Bank losses require government support, which might make government debt unsustainable, as seen in Ireland in 2009. But sovereign fragility can also hurt the banking sector: the restructuring of Greek government debt in 2011 required in turn a bailout of Greek banks and contributed to the Cypriot crisis in 2013, with both Greek and Cypriot banks heavily exposed to Greek government bond. The Italian government did not meet the banking sector’s problems head-on during the Eurodebt crisis amidst fears that Italy might have been next. However, this delay ultimately turned into a growth problem, as Italian enterprises had increasing difficulties tapping a weakened banking sector for funding. One of the objectives of the European banking union was to reduce if not eliminate this ‘deadly embrace’ of governments and banks. While progress has been made in moving supervision to the European level, with more effective scrutiny of banks, resolution is still mostly at the national level. True, there is a Single Resolution Mechanism, but it has only rarely been activated.
Original sin of the banking union
Ultimately, this reflects what I would call the original sin of the banking union. The above-mentioned Comprehensive Assessment showed MPS and other Italian lenders to have significant capital shortfalls. Yet, it took another three years to address these problems. Talking about missed opportunities. Rather than address legacy losses and force an effective restructuring of European banking in 2014, the new regulatory framework was applied to a banking system still working through the aftermath of the Global Financial and Eurodebt crises and – in the case of Italy – a triple-dip recession.Failing banks are still resolved on the national level and mostly with taxpayer support, be it in Germany (Nord LB), or in Italy. This is also a problem of regional banks and their close connection with local politicians. We see this clearly in Tuscany, but also in Germany with the Landesbanken and in Spain, with the cajas. Yes, supervision has been Europeanised, but banks’ connections with local and national politicians have kept the resolution effectively on the national level and bailouts are still the default solution.
Towards truly European banking?
There is increasing consensus about what needs to be done. First, we need to complete the banking union with a European deposit insurance and backstop for the resolution fund. Second, there should be stronger resolution powers at the European level that allow quicker and more decisive interventions. However, these are necessary but not sufficient conditions for a truly European banking system: only a reduction in political influence over regulatory decisions, both on national and on European level, can help here. Tuscany needs strong banks that serve the local economy and society. However, times have changed and the focus has to move from trying to conserve what is no longer sustainable to building effective and stable finance. Europe should not be seen as the enemy that robs Tuscany of its banks, but as an opportunity to create sustainable provision of financial services.