On 8 May 2020, the European Commission (EC) confirmed that the shareholders and subordinated creditors of banks that receive public support to help them withstand coronavirus-related pressures will not be required to bear losses through write-down or conversion to equity, as would normally be the case under European Union (EU) state aid rules.
This may make it easier for countries such as Italy, where the pandemic is likely to inflate banks’ already high problem loan burden, to support their lenders if necessary. Strategies that could be compatible with EU rules include an asset management company (AMC, or “bad bank”) to buy banks’ problem loans, coupled if necessary with capital injections from the government to help individual lenders absorb credit losses. However, such measures would still face considerable political and technical obstacles, according to Moody’s.
Regulatory obstacles to supporting banks diminish
Temporarily relaxing the requirement that investors bear losses removes an obstacle to the “precautionary recapitalisation” of solvent banks to preserve financial stability, which is permitted under EU rules. Governments could also use (and if necessary create) an AMC to buy problem loans, including those held by banks eligible for recapitalisation. This would be in line with a 2018 EC “Blueprint” setting out an AMC model that complies with EU state aid rules. Addressing coronavirus-related pressures rather than pre-existing weaknesses would have to be the main objective, although this distinction may not be easy to make in practice.
Political hurdles remain
Italy’s existing €400 billion coronavirus-related loan guarantee package protects banks against new lending risk. However, it does not fully address a likely drop in the value of their legacy bad debts, which will require additional provisions. Using more taxpayer funds to relieve this pressure may face political resistance, even if compatible with EU rules. The European Stability Mechanism (ESM) is a potential funding source, but this option would also face political obstacles, both in Italy and among the ESM’s 18 other members.
Italian banks’ problem loans are already high
Italian banks’ nonperforming loans (NPLs) peaked at 18% of gross loans in 2015. The NPL ratio fell back to 6.7% by end-2019 primarily thanks to disposals and securitizations encouraged by the European Central Bank (ECB). However, it still far exceeds the eurozone average of 2.7%.