Italy’s Imposition of a Systemic Capital Buffer for Large Banks Is Credit Positive
On 30 November, the Bank of Italy (BOI) introduced a systemic capital buffer for the country’s other systemically important institutions (O-SIIs), namely UniCredit SpA (Baa1/Baa1 stable, ba12 ), Intesa Sanpaolo SpA (A3/Baa1 stable, baa3) and Banca Monte dei Paschi di Siena S.p.A. (Montepaschi, B2/B3 review direction uncertain, ca review direction uncertain). The introduction of the buffers, which begins in 2017, is credit positive because it will force the banks to hold more common equity Tier 1 (CET1) capital relative to their risk-weighted assets, therefore strengthening their loss-absorption capacity. Exhibit 1 provides phase-in details of the buffers for each bank.
Increasing capital requirements will also send a positive signal to the market because it shows that regulators have acknowledged the challenges that Italian banks currently face, including supervisory pressure to reduce their large stock of problem loans and increase provisions, which may necessitate more capital. Italian banks are having difficulty disposing of problem loans without incurring losses because market prices are significantly lower than book values. Euro area banks must comply with a prudential capital ratio that the European Central Bank sets as part of the supervisory review and evaluation process (SREP). The SREP requirement is composed of three elements: a minimum CET1 ratio of 4.5%, a capital conservation buffer and potentially additional capital (Pillar II). Other buffers on top of the SREP compose the capital requirement, including the buffer for O-SIIs, and are set by member countries, which tailor the buffer individually and aim to address the “too big to fail” issue. Its calibration is based on a methodology set by the European Banking Authority and whose factors include size, complexity and interconnectedness. Pending communication of new SREP levels, Intesa easily meets its 10.25% requirement for 2021, with a fully loaded CET1 of 13% as of September 2016 (Exhibit 2). UniCredit’s fully loaded CET1 of 10.82% as of September 2016 is close to the 10.75% requirement that the bank must meet in 2019.3 We expect UniCredit to announce a significant strengthening of its cushion over requirements as part of its strategic review this month. Montepaschi’s fully loaded CET1 ratio of 10.7% as of September 2016 is below its 11% requirement for 2021 and the bank had negative capital in the European Banking Authority’s stress test. The bank is undertaking a debt exchange and capital raise4 that, if successful, will allow it to meet its current and future capital requirements.
