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«BLUEPRINT SERIES 25 EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHS Dirk Schoenmaker and Nicolas Véron, editors Thomas Gehrig, Marcello Messori, ...»

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Despite the rigidity of the adopted criteria, the major Italian banks performed better in the late-2015 SREP than in the 2014 96 In contrast to Pillar-1 requirements which are standardised (under CRR in the EU), Pillar-2 capital requirements address risks that are specific to each bank and involve supervisory discretion. The supervisor may also impose Pillar-2 capital guidance, if the capital requirements can be unmet under specific circumstances (European Commission, 2016).

97 Patrick Henry, (2015) ‘Bank of Italy slams ‘arbitrary’ ECB over capital demands’, Bloomberg, 21 September.

98 At the end of the 10 March 2016 press conference, Draghi said: “…I want to point your attention to a communication by the Commission […] that does clarify the nature of Pillar-2 requirements”. This Communication acknowledges that “competent authorities may impose additional Pillar-2 capital requirements to address the more specific risk profile of each institution”. However, it adds that these same authorities have to “provide clear and detailed justification to the institution of why Pillar-2 capital guidance is transformed in a Pillar-2 capital requirement” and “the institution concerned should have the right to appeal the decision” (see European Commission, 2016).

122 | BRUEGEL BLUEPRINT comprehensive assessment. The latter’s unflattering picture of the Italian banking sector triggered various initiatives by the Italian banking sector or imposed by the government, which included more recapitalisations, attempts to restructure or liquidate part of the NPL stockpile, and changes in corporate governance. On this last point, in March 2015, the Italian Ministry of Economy and Finance signed an agreement with the Italian banking foundations to reduce the foundations’ stakes in each bank, and separately conducted a normative reform of the largest Banche Popolari (over €8 billion in total assets), requiring them to move towards a one-share-one-vote framework by July 2016. More recently (April 2016) the ministry implemented a normative reform of the Banche Cooperative to consolidate them into a few banking groups or to transform them into joint-stock companies.

Meanwhile, despite their persistent weaknesses in terms of organisation and governance, MPS, Carige, BP Vicenza and Veneto Banca were able either to meet the specific capital requirements set by European banking supervision, or to commit to a sufficient recapitalisation within an agreed timeframe (see below).

As mentioned above, LSIs are important in Italy. They currently represent more than a quarter of total assets, with no large institutional protection schemes. Some of these smaller banks either came under special administration (an Italian form of corrective action) or were otherwise in need of significant restructuring. The SREP process shed light on their most pressing problems. However, EU competition policy rules that entered into force in August 2013 (European Commission,

2013) limited the Bank of Italy’s ability to address LSIs’ weaknesses in its role of direct supervisor. These rules mandate losses on shareholders and junior bondholders as a precondition for state aid, and thus severely restricted state guarantees on the securitisation of NPLs, as detailed below. On this basis, the European Commission Competition Directorate-General placed constraints on the utilisation of an Italian inter-bank fund to resolve bank crises. Moreover the BRRD, approved in 2014, extended the principle of bail-in to all types of bank bonds and

123 | EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHS

deposits above €100,000 from the beginning of 2016 but, at the same time, set the normative framework for banks’ crisis management99. The Italian Parliament was late in transposing BRRD into national legislation, which was only done in mid-November 2015100.

Recent developments and prospects In November 2015, these constraints crystallised in the Italian approach to addressing the weaknesses of four small banks (three regional savings banks and one cooperative bank) which, combined, held around 1 percent of total Italian banking deposits. The impossibility of finding solutions through the national inter-bank fund brought the structural fragilities of the Italian banking sector to the fore. The Italian government spun off the NPLs of these failing banks into a single ‘bad bank’ at around 18 percent of their nominal value, as required by the European Commission, and formed four new viable banks. In the process, the value of shares and subordinated bonds previously issued by the failing banks was wiped out. Since the Italian banking sector had sold an abnormal amount of different types of bank bonds to retail investors between 2001 and 2012, the obliteration of the value of subordinated bank bonds created alarm. It also affected the market values of all listed Italian banking groups101.

99 See Visco (2015, 2016). In these works, the Governor of the Bank of Italy compares the application of these new European rules with the introduction of total loss absorbing capacity (TLAC) requirements for the systemically important banks. TLAC was decided by the Financial Stability Board in 2015 and must be implemented before 2022; conversely, the new European rules have very short transition periods and retroactive effects on outstanding debt. Visco argues that this hasty European implementation has a distortionary impact.





100 This late transposition implied that the Italian authorities were left with little time to implement the new rules on crisis management before the full implementation of the bail-in.

101 The negative market reactions at the beginning of 2016 were worsened by the spreading of false news. For instance, an ECB Supervisory Board inquiry at a number of European banks on their NPL stock was interpreted as a sign of a further and generalised strengthening of capital requirements for the Italian banks.

124 | BRUEGEL BLUEPRINT At the beginning of 2016, the Italian government reached a controversial agreement with the European Commission to offer a partial and costly guarantee to Italian banks securitising their NPLs (Italian Ministry of Economy and Finance, 2016). It soon became apparent that this guarantee, limited to the senior tranche, would be ineffective to reduce significantly the gap between the average value of NPLs accounted for by the Italian banks (around 41 percent) and the benchmark value set in the case of the four failing banks (around 18 percent). The size of this gap meant that Italian banks would have been unable to liquidate a significant portion of their NPLs without resorting to further recapitalisation. In the European context of a still unfinished banking union, these events highlighted the fragility of the Italian banking sector. They further jeopardised the scheduled recapitalisations of BP Vicenza and Veneto Banca which had still to meet their SREP capital requirements and were charged with administrative misbehaviour in previous liquidity raisings; and put the other banking groups with the highest weight of NPLs – MPS and Carige – under strain. Separately, at the beginning of April 2016, the ECB approved the first significant bank merger under its supervision, between Banco Popolare and BPM102. This piece of good news, however, failed to counterbalance the bad news on other fronts.

In April 2016, the Atlas fund (Atlante in Italian) was launched as Italy’s response to this situation. The fund, endowed with an initial capital of €4.25 billion by a large majority of the Italian financial institutions, has two aims: to underwrite new recapitalisations by Italian banks (up to 70 percent of its capital), playing the role of ‘shareholder of last resort’ and to act as a purchaser for the junior tranches of, 102 ECB banking supervision approved this merger after a lengthy negotiation on NPL liquidation, the re-capitalisation of Banco Popolare and changes to the governance of BPM. Italian newspapers complained about the Supervisory Board’s rigidity because both banks had already met the 2015 SREP requirements. However, the new banking group will be stronger thanks to these additional requests being met.

125 | EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHS

securitised Italian NPLs (up to 30 percent of its capital).

The governance and operation of this fund have at least three weaknesses. First, Atlas’s endowment is insufficient to pursue its double aim, even under optimistic assumptions of its possible leverage ratio; the two recapitalisations of BP Vicenza and Veneto Banca could consume 85 percent of the capital devoted to this task, almost extinguishing Atlas’s capacity. Second, Atlas’s design implies that the stronger financial institutions subsidise those in trouble: it is debatable whether this solution should be chosen over a new round of consolidation. Third, Atlas’s ownership structure is such that its main shareholders, the Italian banking groups, are also its contracting parties, meaning that the same set of agents will act on the two opposite sides of the market, which can hinder competition and generate conflicts of interest. Despite these weaknesses, Atlas might effectively temper financial instability in the short run. At the beginning of May 2016, it acquired full ownership of BP Vicenza, whose capital call had attracted demand from market investors for less than 10 percent of the amount requested. Without this intervention, either Unicredit as a formal guarantor of the capital increase would have had to buy the new shares, with a negative impact on its CET1, or BP Vicenza would have had to enter into a resolution procedure. At the time of writing, the same could happen in the case of Veneto Banca and its guarantor, IntesaSan Paolo. Moreover, Atlas still wants to increase the market prices of Italian NPLs, and thus to allow banks such as Carige and MPS to reduce the expected losses from the gradual liquidation of their NPLs.

The threat of financial instability does not imply that the Italian banking sector is on the brink of bankruptcy. Moreover, given the ECB’s policy of quantitative easing and other non-conventional initiatives, the Italian banking system has never faced serious risks of illiquidity. Even so, Italian banks will be unable to play a significant and efficient role in intermediating financial wealth and lending to the Italian economy without restructuring and consolidation. The implementation of these processes is not made easier by the lack of 126 | BRUEGEL BLUEPRINT trust among euro-area countries, and between them and the European institutions. This mistrust risks making European banking regulation and supervision excessively rigid; an excess of rigidity could hinder the actual construction of a single financial market.

9 The Netherlands Casper de Vries and Dirk Schoenmaker The Dutch banking landscape The Dutch banking system is highly concentrated. There are three very large banks: ABN AMRO, ING Group and Rabobank. ABN AMRO was formerly part of Fortis and is still 77 percent government-owned following nationalisation in October 2008 and relisting in November

2015. ING Group is now predominantly a banking group after spinning off most of its insurance activities (under the name Nationale Nederlanden) in 2014, as requested by the European Commission following state aid received in 2008. Rabobank is a non-listed cooperative group.

There are three medium-sized banks: SNS, BNG and NWB.

SNS Bank, originally a savings bank, is wholly government-owned following the nationalisation of failing group SNS Reaal in February 2013.

When SNS was nationalised, the Dutch government separated the insurance subsidiary, which was renamed Vivat and subsequently sold to the Chinese insurer Anbang in 2015, and the property subsidiary, which had large non-performing commercial property investments.

Now that the remaining SNS Bank is healthy again, the Dutch government is considering privatisation and will send its proposals to the Dutch parliament before the summer of 2016.

128 | BRUEGEL BLUEPRINT

–  –  –

Source: DNB and annual reports.

BNG Bank (Bank Nederlandse Gemeenten, Dutch Municipal Bank) and NWB (Nederlandse Waterschapsbank, Dutch Water Bank) are also publicly-owned (50 percent by the central government and 50 percent by local governments for BNG; and 81 percent by the local water authorities, 17 percent by the central government and 2 percent by local governments in the case of NWB). BNG and NWB mostly lend to municipalities, provinces and polders administered by the local water authorities. The government intends to divest all shares it holds in ABN AMRO and SNS Bank. Meanwhile, the Dutch government has benefitted from dividends from ABN AMRO. Lately, there has been some public advocacy in favour of keeping SNS as a state-owned bank

129 | EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHS

(Financieele Dagblad, 2016).

There are several smaller banks (LSIs), which amount to 12 percent of the Dutch banking system’s total assets. The largest players among the LSIs are NIBC, LeasePlan Corporation and Van Lanschot, with total assets ranging from €15 to 30 billion. Table 8 provides an overview of the Dutch banking system, indicating that only 7 percent is foreign owned. The Dutch national supervisory authority is the National Central Bank, De Nederlandsche Bank (DNB), which also has resolution authority.

Comprehensive assessment In 2012 DNB started to raise public awareness of potential valuation problems in the commercial real estate sector and asked for better risk management. DNB stepped up its supervision by starting an in-depth investigation of banks’ real estate portfolios. In 2013 DNB conducted an asset quality review of all major banks, which resulted in higher provisions and adjustments in internal risk models. The supervisor also requested additional capital for commercial real estate exposures.

This sectoral asset quality review helped the Dutch banks to prepare for the ECB’s comprehensive assessment of 2014. The comprehensive assessment did not lead to substantial adjustments for the Dutch banks.

More recently, DNB has again been warning commercial banks to take heed of the new Basel Committee proposals regarding residential mortgages. As discussed below, these proposals will have a material impact on Dutch banks that have relatively large mortgage portfolios with high loan-to-value (LTV) ratios. DNB is asking banks to anticipate these new measures and take action now.

Significant institutions The government aims to sell its remaining shares in ABN AMRO in later tranches. While there is political agreement on full privatisation, there is no indicative timetable. Following the IPO in November 2015, 130 | BRUEGEL BLUEPRINT there was a lockup period until May 2016.

ING is an international bank, with operations across Europe and beyond. These include significant activities in the euro area, particularly in Belgium, Germany (ING DiBa), Netherlands, Luxembourg and Spain. While the supervisors in the Joint Supervisory Teams (JST) are still learning, early experiences suggest that (1) the joint supervisory process is working; (2) the SSM approach is more intense than the former DNB-led regime; (3) there is useful specialisation on topics such as capital and liquidity within the JST; and (4) the JST approach enables the SSM to have an overall, consolidated, view of the banks that was not achievable under the pre-SSM system. Nevertheless, the metrics that the SSM is using and the benchmarking against other banks are not (yet) transparent. A case in point is the SREP process, in which the SREP score is announced to the banks, but the underlying factors that contribute to this score are not.

Rabobank underwent a major change of governance in 2015, which could have implications for the governance of other cooperatives in the euro area. Until 2015, the local member banks were owned by their customers (only those that chose to be a member). The local member banks were in turn members and owners of Rabobank Nederland, the central institution. The central institution of the Rabobank Group and all 106 local member banks merged into one entity, Cooperatieve Rabobank U.A., with one banking licence and one consolidated balance sheet as of 1 January 2016. There are several

reasons for this merger:



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