Investing in Italy – bail-ins and bail-outs, what does this really mean?
I recently saw an article on Bloomberg, which gave me some cause for concern since I know that some people have invested in, or more likely were to invest in, the Bonds of banks in Italy as an alternative to cash.
However, this may no longer be such a wise choice and to find out why, read on.
Italians hold about 200 billion euros of bonds in Italian banks and this has always been a good source of funding for banks given that Italians have traditionally been very loyal to their national banks. The Bonds have chiefly been a cheap source of lending for the banks and whilst interest rates have remained at historic lows, even offering a marginal rate higher than cash has encouraged Italians to invest more in Bonds with a tendency to use them as an alternative to cash rather than see them as a debt obligation.
However, this is very likely to change given problems at 3 of Italy’s bigger banks Banca delle Marche SpA, Cassa di Risparmio di Ferrara SpA and Banca Popolare dell’Etruria e del Lazio which are all currently being run by government appointed administrators.
The problem arises from the recent past and how the EU dealt with the crisis in Cyprus. A new term was coined in how this crisis was dealt with, namely a bail-in.
What is a Bail-out?
A Bail-out occurs when a government steps in to inject liquidity into a failing bank or institution to protect it from going bankrupt and therefore protecting savers and in this case, investors in that institution, e.g. Northern Rock, Lloyds TSB and Royal Bank of Scotland in the UK.
And a Bail-in?
A tool which is now deemed to be equally acceptable (to reduce the future burden on taxpayers) is to use a bail-in. This is where the existing creditors, bond holders and shareholders, have to accept a write down on their assets or they are written off entirely.
Am I protected by the Bank Depositor Guarantee?
The simple answer is No. A bond, unlike cash, is a loan that you have made to the financial institution in question for a pre-agreed rate of interest in return. The bank depositor guarantee of €100,000 per banking group only extends to cash deposits.
So what happens next?
From January 2016 the new EU bail-in came into force to ensure that taxpayers are not the first in line when faced with the burden of failing banks and financial institutions. Shareholders and Bondholders will be the first to suffer losses!
The 3 guilty parties mentioned above have approximately €900 million of debt on their books and are unlikely to raise new money from the Italian retail investors due to the increased risk of the bank being in administration, and the possibility of a bail-in.
Existing Bond holders will now have the concern of how to get rid of these Bonds, which were often marketed as cash based alternatives paying higher rates of interest, when actually they are a higher risk asset in a failing bank. The asset could very well be written off, or less favourable terms offered, for those banks who are failing or in administration.
What is the likely impact?
The Italian banks aforementioned and others alike will probably see sales in their Bonds fall dramatically and therefore have to offer much higher rates of interest to attract future capital. If this is the case, then banks in trouble will either a) fail due to increased costs b) merge with other Italian banks to reduce borrowing costs or c) allow foreign competition to enter the market through takeovers.
However, the main issue is when advised to buy a Bond with a bank with which you do your daily banking, you actually fully understand the risk involved and that it is not an alternative to cash at all!!
If you have Bonds in any of the above named Italian banks, or you hold Bonds in other Italian banks, then it may be worth reviewing your finances to ensure that you could take the shock of the bank failing and your assets being worth nothing at all.
Disclaimer: The views expressed here are my own. They are not necessarily shared by The Spectrum IFA Group or any other company named or implied. They are subject to change at any time based on market and other conditions.
This is not an offer or solicitation for the purchase or sale of any Security and should not be construed as such. Neither should this be considered tax advice. If in doubt we always recommend that you consult a suitable qualified tax consultant. References to specific securities or companies are for illustrative purposes only and are not Intended to be, and should not be interpreted as recommendations to purchase or sell such securities.