The opportunity in Italy’s banking crisis

The imminent failure of Italy’s third-largest bank, Monte dei Paschi di Siena, is finally bringing the country’s long-festering banking crisis to the center of European leaders’ attention. This may be a blessing in disguise, offering the best chance yet to achieve a lasting solution — and even strengthen the European Union.
Italy’s financial woes have been years in the making. Cronyism, poor lending standards and a double-dip recession generated more than 350 billion euros in bad loans, turning many institutions into zombies incapable of providing the fresh credit needed to support economic growth. Successive governments avoided a proper reckoning, in part because European bank-resolution rules would require them to impose losses on creditors, including mom-and-pop investors who bought bank debt without recognizing the risks. Events have brought Italy to what may be a turning point. Monte dei Paschi’s inability to raise private capital has shown that some banks can’t solve their problems on their own. The European Central Bank, newly responsible for overseeing the euro area’s larger institutions, is pushing harder for action. And with the distraction of the Dec. 4 referendum out of the way, Italy’s new government may be able to muster the political will.
What needs to happen? The country’s banks require more new capital than they can raise on their own, and more than EU rules would typically allow the government to provide. Creditors should indeed bear some of the burden, or else they’ll conclude that taxpayers will always bail them out — but after allowing for what’s feasible in that regard, there’s still a shortfall.
Europe should therefore let Italy invoke an exception in the banking rules, enabling the government to nationalize Monte dei Paschi — and a few others as well — for long enough to restructure them and reform their governance. At the same time, Italy’s government should impose losses on creditors, while setting up a fund to compensate retail investors who were duped into buying risky bank debt. Finally, Italy should submit hundreds of other banks to a comprehensive ECB assessment, determining which to salvage and which to shut down.
These measures would help the economy, which needs all the help it can get. They might also pave the way for completing the euro area’s banking union, which is meant to prevent troubled banks from undermining national-government finances and vice versa. Proving that the ECB and Italy can act effectively could make other euro-area members (notably Germany) more amenable to risk-sharing through initiatives such as mutual deposit insurance. Without such mechanisms, the common currency may not be viable in the longer term.
Granted, all this is a lot to ask, and Italian and European officials haven’t yet distinguished themselves in these matters. This is a good moment to be more decisive. It would be a shame to let this crisis go to waste.
—Bloomberg