Europe: New wrinkle in bail-in efforts - BBH

Research Team at BBH, notes that after the 2007-2008 bank recapitalization by governments, which means taxpayers' money, Europe changed the rules.  

Key Quotes

“The new rules require that private investors are "bailed in" before the bank is "bailed out." Europe's fastidious with rules allows for exceptions and flexibility.  Italy is pushing for this flexibility now, and Portugal is watching closely because its largest bank also may require recapitalization.  

However, there is another source of relief is a little more than a week away.  On July 19, the European Court of Justice will hand down its ruling on 2013 case brought to it by Slovenia over its bank bailout. The Advocate General made a preliminary judgment in February.  The European Court of Justice upholds that Advocate General 80% of the time, according to reports.  

So what did the Advocate General say?  Essentially he threw shade on the Bank Recovery and Resolution Directive that forces private investors to take losses before public money can be provided.  The Advocate General argued that the EC has not binding powers on this issue and that bailing in investors is not a prerequisite to using of government aid.  The EC, according to the Advocate General, cannot force losses on private investors.  

The Bank Recovery and Resolution Directive (BRRD) outlines the process of recapitalizing banks with state money.  The issue is not whether the state funds can be used, but who must take losses first.  In Italy, nearly half of the bank bonds were reportedly sold to retail investors.    Bailing them in as investors risks hurting the fragile economy further through consumption.  

The Italian referendum in October is the next major political challenge in Europe. The referendum is about constitutional changes to reduce the size and power of the Senate.  

If the referendum loses, which appears likely now according to polls, Renzi has indicated he would resign.  The bottom line is that if the referendum losses and Renzi resigns, Italian politics potentially would be a significant disruption.  

The market seems to be sensing that the tide is turning in Italy's favor.  Between the European Court of Justice, which would de-fang the BRRD (July 19) and the ECB's stress tests (July 29), that Italian banks will be the support they need.  It is too early to tell whether the condition of the aid will be putting some closure of the NPL problem that is saddling several Italian banks.”