Monthly Archives: October 2011

The oldest bank in the world

Yes I am back. I know it has been a while. What can I say? I have been quite busy!

One of the things taking up my time during the week was preparing for and then giving a talk for the Q-Group on operational risk capital modelling. It sounds arcane, I know, but there was one exciting part: I had the opportunity to try out the simulated laser pointer that you can create by pressing your finger on the screen of the iPad during a Keynote presentation.

Since regulators expect banks to use their capital models to quantify 1 in 1,000 year losses, I slipped a reference in my presentation to the Italian bank Monte dei Paschi di Siena which, having been founded in 1472, is a mere 539 years old. The somewhat oblique point was that no-one should take these models too seriously.

Monte dei Paschi

Monte dei Paschi di Siena

It was an ironic twist that evening that this was headline on the front page of the Wall Street Journal website:

Siena Headline (II)

It seems that Monte dei Paschi di Siena was one of a number of banks suffering as a result of the European sovereign debt crisis and it makes an interesting case study of the challenges of the business of banking.

Back in the original days of the global financial crisis, the banks that got into the most trouble were the ones with significant exposure to “toxic assets” (US mortgages, mortgage-backed securities and their ilk). Once people started to worry about these toxic assets, the problem was that no-one really knew how much exposure any given bank had to these assets and so no-one wanted to lend to anyone else. Since many banks (including Australian banks) rely on wholesale debt markets (i.e. they borrow money from big institutional investors around the world like pension funds), this became a problem for everyone.

Back then you might have thought that a regional bank like Monte dei Paschi di Siena would be fairly immune to what was going on, but it got off to a bad start in the crisis by acquiring another bank, Banca Antonveneta in 2007. In retrospect (and even at the time in the eyes of some analysts), it paid too much and over-extended itself at the wrong time. Within a couple of years, its capital buffers had become so thin that it was forced to turn to the Italian government for a capital injection and also cut its dividend payments right back in an attempt to rebuild. This was painful for Siena because, in a peculiarity of Italian banking, the majority shareholder of Monte dei Paschi di Siena is a charitable foundation, originally established in the 1990s for the express purpose of acquiring the bank when banks across the country were being privatised. This foundation makes donations to all sorts of public groups across the city of Siena and, with the dividend cut, the donations stopped too.

To make matters worse, the bank is a large holder of Italian government bonds, which have not been performing particularly well of late. With a capital base of €7.1 billion (figure as at April 2011), it held €32.5 billion (figure as at December 2010) in Italian government bonds and so any decline in value of Italian government bonds put pressure on the bank’s capital. In mid-2011, in the face of the European debt crisis, the bank decided it needed to further bolster its capital position. But the foundation did not want to lose its majority share-holding, so the foundation turned to JPMorgan and Goldman Sachs (aka the vampire squid) to borrow money to buy new shares issued by the bank. Unfortunately the loans were secured by shares and as the share price continued to fall, the foundation had to hand over more shares to its lenders. If things do not improve, the foundation is likely to be forced to sell more shares, ultimately losing its majority stake in the bank. The foundation, which once made around €250 million a year in donations to the city, is not looking likely to be able to contribute nearly as much to the public good in the future.

Will this venerable bank be the first to survive for 1,000 years? It has not failed yet, but the immediate future still looks rather shaky.

What will the Reserve Bank do this week?

It has been a while since I have had a Reserve Bank poll here on the Mule. The Bank will be sitting down on Tuesday to decide whether or not they should adjust monetary policy. Westpac chief economist, Bill Evans, was the first of the bank economists to start predicting that the next move in the cash rate would be down back in July. Since then, some other economists have come around to Bill’s perspective, particularly given the global financial chaos as European banks face a slow-motion bank run. Others are still expecting that the Reserve Bank’s bug-bear, inflation, will remain sufficiently threatening to ensure that the next move in rates is up. But perhaps it is too soon for the Bank to do anything at all.

What do you think? Get your vote in before the announcement is out at 2.30pm on Tuesday (Sydney time).

UPDATE: the results are in and Mule readers got it right: 93% of respondents thought there would be no change in cash rates, which was indeed the case. No-one predicted a rate rise.