ECB’s Monte Paschi capital bar would trip up 10 other EU banks

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(Dec 30): Deutsche Bank AG, UniCredit SpA and eight other European Union banks would fall short of the European Central Bank’s capital demands on Banca Monte dei Paschi di Siena SpA based on stress-test results, highlighting potential objections to the plan.

The ECB told Monte Paschi it needed enough capital to push its common equity Tier 1 ratio to 8% of risk-weighted assets in the adverse scenario of the stress test, the Bank of Italy said in a statement late on Dec 29. That’s well above the legal minimum of 4.5%. This year’s health check had no pass mark, but in 2014 lenders were held to a CET1 ratio of 5.5%.

Monte Paschi was the worst performer in the stress test’s adverse scenario with a CET1 ratio of minus 2.4%, followed by Allied Irish Banks Plc with 4.3%. The Italian government is planning a bailout of Monte Paschi. Under European Union law, state aid can be given to solvent banks to cover a stress-test shortfall, but the absence of a hurdle means the size of the gap could be disputed, when Italy seeks approval for the rescue from the European Commission.

“There’s a lot more to be explained,” said John Raymond, senior European bank analyst at CreditSights. “They just say, ‘Oh, this is needed to get to 8 percent,’ as if we all knew the number was 8 percent, when in fact that’s a completely new number.”

Debt Conversion

The government in Rome is planning a so-called precautionary recapitalization for Monte Paschi. The Bank of Italy said the ECB’s demands for an 8% CET1 ratio and a total capital ratio of 11.5% translate to a shortfall of 8.8 billion euros (US$9.3 billion).

Closing the CET1 gap requires 6.3 billion euros of high-quality capital, 4.2 billion euros of which will come from converting subordinated debt to equity, with the remainder provided by the government, according to the Bank of Italy. Another 2.5 billion euros will be needed to offset capital lost in the debt-to-equity conversion to reach the 11.5% total ratio.

A person familiar with the matter said the CET1 premium of 3.5 percentage points above the legal minimum is intended to restore market confidence.

In the stress test, Deutsche Bank emerged with a CET1 ratio of 7.8%, while UniCredit had 7.1%. The CET1 ratios of Barclays Plc and Societe Generale SA were 7.3% and 7.5% respectively.

Adverse Scenario

The first step in a precautionary recapitalization is for the supervisor — the ECB in Monte Paschi’s case — to confirm that the bank meets minimum capital requirements and is solvent. The supervisor also has to determine the capital shortfall under the adverse stress-test scenario. Both those boxes have been checked.

Monte Paschi’s poor showing in the stress test could be used to justify a higher capital threshold, “because you could argue that they are closer to the adverse scenario being realized,” Raymond said. “But at the same time they are arguing they are solvent and meet the capital rules.”

This may lead Italy, and the commission, to push back against the ECB’s demands, he said.

The Brussels-based European Commission, the EU’s executive arm, said on Dec 29 that it would work with Italy and the ECB to “assess the compatibility of the planned intervention by the Italian authorities with EU rules.”

An ECB spokeswoman declined to comment on the Monte Paschi plan.