How small is too-big-to-fail?
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How small is too-big-to-fail?

Regulators don’t want their banks getting any larger, and are offering incentives for firms to shrink. But as Italy gears up to rescue another firm with less than €50bn of assets, how small does a bank need to be before it’s no longer TBTF?

The failure of Banca Popolare di Vicenza’s €1.5bn IPO, which saw too little private demand to be admitted to trading, and had to be rescued by the government-backed Atlante fund, cast a pall over the restructuring that the Italian banking sector needs.

Next on the agenda was Veneto Banca’s €1bn IPO, which will also likely go to Atlante, while other banks will probably need to issue equity as well — the Italian press reported Carige was looking for another €400m, which the bank denied.

The rescues of Vicenza and Veneto are not state aid — Atlante has been carefully structured to avoid this pitfall — but public bank Cassa Depositi e Prestiti is putting up cash, and the rescues have been co-ordinated by Italian authorities, not least by allowing the other investors in the rescue fund to treat their exposures leniently.

But they are, nonetheless, rescues of banks which certainly shouldn’t be “too big to fail”. Both have total assets below €50bn. Monte dei Paschi, the smallest of what Italy’s central bank designates “other systemically important institutions”, has a balance sheet of around €170bn.

They are also rescues of institutions operating in one of Europe’s most over-banked markets.

“Reform” of the Italian banking system has been an agenda item in Europe for years, but this is simply a mealy-mouthed way of saying the sector is hugely over capacity.

Rolling smaller banks up into larger combinations might create economies of scale — but unless it includes closing branches and cutting staff, it won’t change the business much. Hoping that strong banks like Intesa can be tempted onto an acquisition spree runs into the same problem. Intesa has more to gain by allowing its competition to run into the ground and buying any good assets from the bargain basement than it does from acting as white knight to the whole system.

Italian authorities, to be fair, have found themselves in a brutal bind, caught by the crossover between politics and banking regulation. Italy’s banks were capitalised by a web of cross-holdings, foundations and cooperatives, meaning that the allowance of failures burns not risk-taking institutional equity funds, but the rest of the system and individual savers.

In this respect, Atlante, which has been supporting bank capital raising by spreading the costs between healthy institutions, is a continuation of a long tradition, rather than a departure.

The suicide of a pensioner who lost his savings in the government bail-out of Banca Etruria focused political attention on this problem, and trapped the authorities all the more firmly. Any bankwhere retail investors were at risk when it was placed in resolution became de facto too big to fail, however small it was in practice.

The ownership structure of Italy’s banking system is a particular minefield, but no other jurisdiction in Europe has yet managed to demonstrate that banks, of any size, can be allowed to fail either. This isn’t a disaster — banks and the state have always had a tight relationship — but it is dishonest.

A large chunk of post-crisis regulation is based on the idea that certain institutions are so large, dangerous and significant that they must comply with extra reporting and capital requirements so that they can readily be bailed-in, keeping their operating subsidiaries bombproof.

But if small banks in a bloated system cannot be allowed to fail, then who can? The caution of supervisors, nervous about using new resolution tools and even more scared of insolvency, is understandable.

Perhaps, though, they’d be better off coming up with a list of institutions which are “small enough to fail” — it would be short, but at least it might be credible.

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