Avoiding a bail-in of junior bond-holders might be possible in the convoluted way discussed. This would require that (i) the Italian government obtains the green light for a precautionary recapitalisation under Article 32(4.d) of BRRD; (ii) the resulting state aid is approved under Article 107 TFEU and (iii) the “financial stability” clause in the 2013 Banking Communication is granted to suspend burden sharing of junior bondholders. Even assuming that all these conditions fall into place, the most important question remains whether burden sharing should actually be avoided. In my view, there are three reasons suggesting it should not.
First, the “constitutional right to save” argument that is being made by some in Italy is certainly appealing to the public but it is misplaced. The whole idea neglects the fundamental difference between savings and investment. Placing savings into banks’ junior bonds is an investment, and it bears risk. The Italian constitution does not and should not grant a right to be always and unconditionally bailed out of bad investment decisions. Indeed, allowing investors to believe this would be dangerous. What people should be granted is the right to receive proper information and not be misled into risks of which they are not aware or which they are not prepared to take.
This brings me to the issue of mis-selling, which surely plays an important role in today’s situation. Monte dei Paschi di Siena offers a good example. Its largest outstanding junior bond, due in 2018, was sold in the banks’ branches to anyone willing to invest at least EUR 1000. Coincidentally, this is the same minimum investment required for buying Buoni Ordinari del Tesoro — a type of (safer) government bonds in which Italian households traditionally invest. The Italian Securities and Exchange Commission signed off on this back in 2008.
Mis-selling should obviously have been better prevented in the past, but it does not per se justify the bailout of all junior bondholders today. It would be wrong to assume before investigation that all junior holders were unaware of the risk they took, and it would set a tricky precedent. The Italian government should rather opt for bailing in junior debt now and establishing an ex-post compensation scheme for the retail investors who can be truly considered victims of mis-selling.
This has been done already, to compensate the retail holders involved in the Italian resolution cases of 2015. They have been bailed in, and then given the option to ask for a reimbursement of 80% of the sum spent to buy their junior bonds, provided that they had bought before 12 June 2014, that they owned less than EUR 100 000 in property assets at the end of 2015 and that their 2014 income was below EUR 35 000 euro. It would be odd and confusing to protect junior bondholders ex ante now that BRRD is in force, after bailing in very similar investors last year.
Second, the risk to financial stability, which is at the core of the argument to justify bail-in suspension, is unclear. Junior bail-in has already occurred in 2015 without major consequences. Now, the banks resolved in 2015 were admittedly tiny compared to Monte dei Paschi di Siena. Nevertheless, there is no evident reason why a precautionary recapitalisation combining bail-in of junior debt with a credible compensation scheme for mis-selling and the protection of senior creditors should necessarily result in financial instability (see also Nicolas Véron on this here).
The government may prefer to avoid bail-in rather than compensating it, because the shock will be immediate and compensation will take time, probably too long to prevent a political backlash before the October referendum. But this is a political risk, not a financial stability issue.
Lastly, the handling of the Italian banking issue has very important implications at the EU level. This is the first time that the BRRD rules would be tested in real life under stress, after entry into force in January 2016. The rationale for having BRRD rules was to finally provide certainty about how banking problems in the EU will be dealt with in the future, and ensuring a coherent application is crucial for establishing the credibility of the new regime.
There is no easy fix to this delicate puzzle. Bail-in is going to be painful in a country that scores low in terms of financial literacy and where households hold a third of all bank debt. But bending the rules to avoid even the junior bail-in that comes with the flexibility of a precautionary recapitalisation would create dangerous confusion with unpredictable effects at the EU level. The best compromise is between the two extremes: a precautionary recapitalisation with burden sharing for junior debt, protection of senior creditors and a credible reimbursement scheme for those who were wronged due to unlawful practices which should have been better prevented.