The rule of flaw

ATLAS could hold up the sky. Atlante, Italy’s bank-rescue fund, looks like a weakling. The fund, which raised €4.25 billion ($4.9 billion) last month, almost half of it from Italy’s two largest banks, has two purposes. One is to act as an emergency investor in banks starved of funds; the other is to kick-start a market in dud loans clogging up banks’ balance-sheets. On both counts, the fund has not done enough to calm nerves. Italy should have acted sooner to sort out its banks. But Europe’s approach to financial crises is also to blame.

Italian officials talk about the fund as a “game-changer”—partly because it has already pulled off a rescue of Banca Popolare di Vicenza (BPVi), a regional bank whose initial public offering (IPO) flopped. But that only underlines how close Italy has come to disaster. BPVi’s IPO had been fully, and foolishly, underwritten by UniCredit, Italy’s largest bank: had not the fund stepped in, UniCredit itself might have run short of capital. A banking crisis at the heart of the euro zone might by now have been raging. As it is, the BPVi’s rescue has depleted Atlante’s firepower. More calls on its cash may be imminent—an IPO by Veneto Banca hardly has investors swooning.

Defenders of Atlante pooh-pooh the critics. The fund has seen off the immediate risk of a crisis, they say, and enough money is left to put a big dent in Italy’s €360 billion of gross non-performing loans (NPLS). Specifically, Atlante is meant to help close the gap between the value that banks put on such assets and the price that investors in distressed debt will pay for them. It is supposed to accomplish this by acting as a junior investor in financial instruments that bundle banks’ bad debts together; by buying the riskiest slices of these investments, it will reduce the chance of losses for those higher up the ladder of investors. The theory is fine. But the appetite of those other investors is unproven. And as the amount of equity in Atlante goes down, so does the amount of risk it can take on.

In the meantime, it is true that the number of duff loans in the system has stabilised and that banks have set aside lots of provisions. A new bankruptcy law, by bringing down the time needed to foreclose on loans, ought to encourage investors to buy NPLs from banks. But gross non-performing loans still make up around 18% of total loans, equivalent to a fifth of Italy’s GDP. And the law applies directly only to new lending; its impact on the stock of bad loans will be more muted.

State flayed

If Atlante is an unconvincing answer to Italy’s woes, that is partly the country’s own fault. It stood by as NPLs soared. But blame also lies with Europe’s new rules for handling banking crises. Tighter restrictions on state aid have prevented Italy from setting up a government-backed “bad bank” of the kind that Spain used to cleanse its banks. In late 2015 the European Commission also ruled that tapping Italy’s deposit-insurance fund to recapitalise four troubled lenders would count as state aid. If the commission concludes that state aid has been given, it automatically means that a bank is deemed to be failing, or close to it, triggering Europe’s new “bail-in” regime. That in turn starts to hand out losses to shareholders and creditors (retail investors among them), risking contagion at other banks. Atlante exists because Italy has precious few alternatives.

The new rules are well-intentioned. State aid can distort competition; bail-in is designed to protect taxpayers from paying for bank failures. But in this instance the outcome is perverse. The Italian state is being forced, in effect, to stand back while its better banks risk being poisoned by the weaknesses of its worse ones. As a result the euro zone’s third-largest economy, and its second-largest public debtor, has been made more vulnerable to a banking crisis. Given a choice between financial stability and the rule book, ditch the rule book.