One euro. It is the symbolic amount paid by Santander to rescue Banco Popular, its historical spanish rival bank, and it is the first result of the supervision by the Single Resolution Board, the authority created two years ago for dealing with failing, or likely to fail, banks. The operation is a consequence of the overwhelming amount of bad loans, or non-performing loans (NPL), that Banco Popular accumulated in the last few years, and it is the first time that creditors of tier one (AT1) securities were imposed to absorb losses and allow the acquisition by Santander.

Monte dei Paschi di Siena (MPS) could have had a similar financial destiny a few months ago, if a serious restructuring of its NPL, a burden of 27 billions, had not taken place. In the case of MPS the European Commission enabled instead the precautionary recapitalisation of the bank. An help granted, not with a light heart, in fact, as the statement declares:

Since a precautionary recapitalisation involves the use of taxpayer money, EU State aid rules make sure that public funds can only be injected in a bank that is profitable in the long-term. This requires the bank to undergo in-depth restructuring with the purpose of keeping its viability in the long-term. Furthermore, the State must be sufficiently remunerated for its capital injection and the bank’s shareholders and junior bondholders must contribute to the costs to limit the amount of taxpayer money.

A seemingly happy-ending that occurs after an annus terribilis which saw the market value of MPS halved because of the effects of the new EU rules of bail-in. Indeed on the one hand, bail-in rules may have helped to contain the moral hazard of European financial institutions. On the other hand they have increased the uncertainty for medium and large investors. Monte dei Paschi di Siena is one of the oldest banks in Europe, ( “BANK FROM 1472” as the logo says), strongly rooted in the economy and politics of territory [*], that has seen the worsening, along with many other Italian banks,of their credit situation at the turn of the economic crisis of 2008, absorbing losses of the local and national levels, through precisely the current NPL, and paying short-sighted strategic choices (the acquisition of Antonveneta in 2008).

MPS, as Banco Popular in Spain, has a central role in the Italian economy. In addition, although not directly “systemic”, like UniCredit, also burdened by the NPL burden, has a central role in the European financial system, as recognized by a recent study by the ECB.

The logic motivating the bailout in the case of MPS and of Banco Popular was the possibility of contagion related to the significant size of both banks in their respective countries.  This “too big to fail” approach however completely overlooks the measurement of the true possible negative externalities that a bank’s asset devaluation or, even, default could really trigger.

Yet, several studies following the financial crisis of 2008 have developed tests to measure the size of financial contagion in the event of devaluation of bank assets (eg. the debt-rank test and the NEVA framework). Previous studies have also provided the theoretical framework for understanding the infection in the presence of bankruptcies. Linked to this, a very recent study has precisely described the conditions under which the failure of a bank does not act further amplification of the losses in the banking system. If these conditions are met, the amount of total loss is exactly equal to that suffered by the bank which was shaken and made default (principle of conservation of the losses within the system). These conditions are many and difficult to achieve. This implies the amplification in most of real cases. However, the study also provides useful information to estimate the amount of total losses as a result of amplification.

The studies mentioned above therefore allow an accurate measurement of remedial measures to ensure the stability of the system (and certainly more precise than an approach based solely on the size of banks). The question is pivotal for two main reasons: first, the knowledge of the actual possibility of contagion allows one to understand if a bailout or intervention is necessary or not. The availability of this knowledge limits the cost to the taxpayer to only really necessary cases, and reduces information asymmetries, thus limiting even further the risk of moral hazard on the part of banks. Second, to have a more precise estimate of the size of the infection is to know more precisely the amount of intervention required. This improves at the same time the effectiveness of the bailout (reducing the risk of additional interventions), but in many cases also reduces the size, and again the cost of intervention to the taxpayer.

Paolo Barucca and Mauro Napoletano. 


[*] The Paschi named after one of the same name from 1419 statute, the act of agriculture and regulation of pastoralism, i.e. the pastures or grasslands, in Maremma. The verses of Dante have a valid reference to the origin of the term and at the same time (jokes of history) curiously prophetic “There of necessity that everything helmets / what ‘In bosom of Benaco can not / And grows a river down through green pastures “(Dante, Inferno Canto XX)