Italy's third largest bank is struggling, and the country's prime minister has resigned, only to be replaced by a caretaker this week. What does that mean for Italy, its citizens, and for Europe?

Dark days may be ahead for Italy's 3rd biggest bank, Monte dei Paschi di Siena.
Dark days may be ahead for Italy's 3rd biggest bank, Monte dei Paschi di Siena. (TRT World and Agencies)

Italy's third biggest bank is facing a crisis. It has put forward a $ 5.3 billion (5 billion euro) recapitalisation plan that was approved by shareholders but received skeptically by investors.

Banca Monte dei Paschi di Siena had asked the European Central Bank (ECB) for a third extension until January 20, 2017 to raise more capital. The draft decision will be adopted unless the ECB's Governing Council objects within a certain timeframe, usually five days.

This comes during a time of broader political instability. Italian Prime Minister Matteo Renzi announced his resignation after Italian voters rejected his proposed constitutional changes in a referendum on November 4.

Paolo Gentiloni this week won the backing of the Italian Senate in a confidence vote, allowing him to step in as a caretaker prime minister.  

What is Monte dei Paschi di Siena?

Banca Monte dei Paschi di Siena (MPS) is Italy's 3rd largest bank (according to research from Ricerche e Studi, based on 2014 figures). Established in 1472, MPS is also the oldest surviving bank in the world, as listed in the Handbook on the History of European Banks.

The centuries-old bank that has outlived many dynasties and kingdoms is facing trouble after five hundred years of existence.

When the European Banking Authority (EBA) published the results of its EU-wide stress tests of 51 banks within the bloc, MPS was rated the weakest lender.

The EBA carries out the tests to see whether EU banks are resilient to "adverse economic developments" and to locate weaknesses.

What is the root cause of the bank's crisis?

"The Monte dei Paschi affair is symptomatic of the contradictions of Italian capitalism, embedded as it is in a dense network of political allegiances and local power relations," said Francesco Boldizzoni, research professor of economic history at the University of Turin, responding to questions from TRT World.

"What is spectacular is not the magnitude of the crisis itself but the appalling sequence of acts of financial fraud and corruption that followed one another over the years, ultimately leading what is supposed to be the oldest bank in the western world to the verge of bankruptcy."

"Monte dei Paschi di Siena is "a story, a very difficult story," Stefano Caselli, professor of banking and finance at Bocconi University in Milan told TRT World. Caselli said he foresees two scenarios for the bank's future.

"Plan A," in which "institutional investors are going to put on the table five billion euros" that the bank is seeking for recapitalisation, which he says is the strategy required by JPMorgan and the like.

"Plan B," he says, is the Italian government buying subordinated bonds from the retail market for two billion euros, transforming them into equity, and increasing its stake in Monte dei Paschi di Siena.

The Italian Treasury currently has a four percent stake in MPS and is the bank's biggest shareholder.

Caselli said he favours "Plan A" if he had to pick one. "The bailing? I don't believe in that. It will be a disaster."

"It's very much a situation like the American banks in the 2008 crisis," said Vito Laterza, a postdoctoral fellow in social anthropology at the University of Oslo and editor of the Human Economy blog.

"You know, Italy cannot fail - it's too big to fail."

Laterza noted that a lot of Italian banks are in debt and the dynamics in Italy "can become very unstable in the next few weeks," but that a clearer picture of Italy's future won't emerge for a while.

Will the resignation of Italian Prime Minister Matteo Renzi affect the plans to help MPS?

Renzi had rejected a state bailout for Monte dei Paschi di Siena in July, but the idea is being discussed again.

Alex Barker, Brussels bureau chief for the Financial Times, has pointed out three options Renzi's successor will have to consider: they can play for time, bail out MPS without harming retailers who have invested in the bank, or seek help from the European Stability Mechanism, an EU agency that would provide bailout funds to MPS and other troubled Italian banks.

"In the end the bank will probably be sold off to some hungry American financial holding company such as JPMorgan, or perhaps to the Qatar Investment Authority," Boldizzoni predicted. "They will be the real beneficiaries of taxpayers' money."

Laterza said that if the Five Star Movement, a party that combines "a mix of far-right elements with so called more progressive elements but still with very strong xenophobic and nationalistic undertones" were to come into power, then Italy's policies, including those for banking and finance, could alter significantly.

Laterza added that for that to happen, however, the "huge bureaucratic mess" stemming from conflicting electoral laws for the two houses would have to be sorted out first, ahead of elections that he said would have to be held by mid-2018.

How will the MPS crisis affect ordinary Italian citizens?

"If a government rescues a bank, then various investors have to be bailed in. They take losses. That starts with shareholders, of course," said Simon Long, finance editor of The Economist, in a recent Money Talks episode, discussing a 2013 EU law that would affect efforts to help MPS.

"Then next up, junior debt holders – that in Italy is a bit of a problem because there are a lot of junior debt holders in Italian banks who are customers of the banks," Long said.

"Local people, retailers who have been encouraged to buy bonds in the bank a lot of them thought were as safe as deposits. They might stand to lose – that's a problem."

Boldizzoni, however, wrote that while a "proper bailout" is prevented by EU legislation, this "does not rule out some form of state intervention justified by the need to protect savers."

How will Italy's crisis affect the European Union?

Caselli said the crisis in Italy would not affect the EU, and that the system, with its intricate mechanisms, keeps on working.

"Europe knows very well what are the pros and the cons, the good and the bad of the Italian economy and Italian banks," Caselli said.

He mentioned Belgium and Spain as examples of countries where the economy went on even without a prime minister.

"In Belgium, it happened. In Spain, Spain remained without a government for nine months," he explained. "My feeling is that the level of stability in Europe is very high."

AUTHOR: Melis Alemdar

Source: TRTWorld and agencies