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Less Flex from the ECJ

19 July 2016 by Gary Kirk

This morning the European Court of Justice (ECJ) was expected to block the European Commission (EC) from using state aid rules to impose losses on private investors in a bank bail-out scenario. This relates to a case brought to the ECJ by furious Slovenian investors who lost their savings following a bank rescue in 2013.

The Bank Recovery & Resolution Directive (BRRD) has a clause which allows individual EU states to invest public funds into their banks which have capital shortfalls in the bank stress tests (when there is an adverse scenario). This obviously allows a state to assist a bank recovery without imposing losses on private investors and thereby avoid a politically sensitive backlash from the electorate. The EC argue that losses are required to safeguard the taxpayer and curb irresponsible lending (despite the EU trying to get the banks to lend more to the consumer and SMEs).

Today the ECJ went back on their statement in February where they said the EC had no binding power on this issue and that private investor losses are not a pre-condition to grant state aid to the banking sector. Now the ECJ has effectively paved the way for the EC to interpret the injection of public funds in a more punitive manner, which is likely to result in private investor losses.

This change of decision has ramifications for Italy, given the current high level of non-performing loans and the expected shortfall by Banca Monti Dei Paschi di Siena (MPS) in the forthcoming bank stress test results. Obviously Matteo Renzi wants to avoid retail investors incurring losses on MPS bonds, as he has an important referendum on the constitution coming up in October. Renzi and his government have been in discussions with the EU/EC to try and get some flexibility on the injection of capital into MPS (and potentially some other smaller lenders) without falling foul of the state aid rules. This ruling has made those discussions somewhat more challenging.

Renzi has a considerable vested interest in resolving this conundrum and we would expect some diplomatic solution to be found, but the clock is ticking towards the stress-test results (due to be published on 29th July) and the Italian banking sector will remain vulnerable until there is some clarification.

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