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Why Italian non-performing loans remain unfinished Brexit business

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THE MASKING of the Italian Non-Performing Loan (NPL) situation via dodgy accounting and false deconsolidation merits far greater profile. Italian banks are more at risk – and present an even greater risk to financial stability than before – on account of their NPLs compared to 2016, when this issue was first getting major press coverage.

This is a Brexit issue because of the unsolved threat to global (and therefore UK) financial stability – and of course we have not distanced ourselves adequately or demanded that any Italian banks operating in London do so through subsidiaries that are separately capitalised, the capital being calculated using a methodology that burns off all of this
trickery.

Much of the risk has been concealed in “securitisations” in which the same bank that sold the NPLs holds most of the bonds issued to finance the sale: effectively a round trip. The bonds needed to get a BBB- rating at least on their own merits, and then the Republic of Italy has been willing to add its guarantee, the Republic of Italy being rated, errr, BBB- as well.

This legerdemain adds no credit enhancement to the bonds but enables the NPL-selling bank to regard the bonds (based, let’s not forget, on the same NPLs that the bank just supposedly sold) as “sovereign risk” and requiring no capital to be allocated against the risk of a credit loss, according to Eurosystem rules.

This trickery thus released almost all the Common Equity Tier 1 (CET1, aka capital) that the bank had allocated against the NPLs to cushion the bank against further losses; the bank had already made some degree of write-down from the original face value of the loan, down to a ‘carrying value’ in the bank’s accounts, and the ‘carrying value’ had to be supported with a given quotient of capital. After the securitisation this ‘carrying value’ was swapped for the face value of the bonds: the credit risk being run by the bank was the same, but their allocation of CET1 was far lower.

These banks now boast CET1 ratios of 12 per cent and more, and government ministers claim there is no further risk to financial stability, but this is only because of the gaming of the Eurosystem rules where one BBB- asset has to be supported with CET1 in a quotient of 15-20 per cent whereas another BBB- asset requires no capital at all.

For further details of the background to Italian NPLs please read: The Italian Non-Performing Loan Story: How the 2016 Securitisation Laws have led to Permanent Zombification of Banks, by Gordon Kerr and Bob Lyddon. 

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