The world's oldest bank is in dire straits. Again

You can understand why Italy might want to hand yet another round of state aid to Banca Monte dei Paschi di Siena SpA. It is, after all, the world's oldest bank. And while by no means systemic, the lender is large enough to rock the country's finance industry. Paschi also employs thousands in Siena.

But protecting a city's livelihood shouldn't come at any cost. Keeping investors in the dark about the bank's real financial health and skirting around state aid rules — which is what happened when Paschi was last rescued only three years ago — would create lingering damage and undermine trust in the institutions that govern Italy and Europe. 

Paschi's most recent financial report, published on Nov. 13, is hardly reassuring. In it, the bank says it expects capital to fall below regulatory requirements, without elaborating on the size of the deficit. But on Nov. 5, when the bank first reported its earnings for the months through September, it had said capital buffers still exceeded regulators' demands.

What changed between these two filings is unclear. Bluebell Partners, an adviser to Paschi shareholders seeking damages for its past misdeeds, has asked regulators to shed light on the discrepancy. A Paschi spokesman declined to comment.

What's more, in the Nov. 13 report Paschi says it is a going concern because the government (which owns about two-thirds of the bank) supports strengthening its capital to meet the regulatory minimum. Would the bank not be a going concern without those funds? True, having the Italian state as a shareholder gives comfort that private investors wouldn't be able to provide. But whether taxpayer funds can be deployed isn't certain. One constraint is the international rules by which Italy needs to abide.

Italian press reports say Paschi may need as much as 2.5 billion euros ($3 billion) of government funds to persuade UniCredit SpA, a bigger rival, to take over the bank. Taxpayer money could cover the capital shortfall, in addition to the costs of merging with UniCredit, which may also be shielded from Paschi's legal risks. What these government funds would cover matters, and not just because Italian taxpayers deserve to know. The lender has been pushed to the edge because of past wrongdoing; the pandemic, which has prompted Europe to loosen state aid rules, shouldn't be used as cover for yet another rescue.

Paschi, a regional commercial bank, never recovered from buying a rival it couldn't afford in 2007. Since then, a series of desperate attempts to keep it afloat and halfhearted restructurings have left it limping. Two counts of fraud by two different sets of the lender's managers didn't help.

Spiraling legal claims and bad loans, accumulated well before the pandemic, are now weakening the lender's solvency. But how much capital the bank needs this time around, in what would be the fourth state-backed funding since 2009, is educated guesswork. The European Central Bank, the lender's principal regulator, plans a stress test next year. The exercise should reveal any likely future shortfalls from souring loans in the economic downturn, probably adding to the existing deficit.

The European Union has relaxed its state aid regime to let member countries save businesses put under strain by Covid-19. It is even letting nations recapitalize lenders, provided the banks aren't likely to fail. The ECB said it couldn't comment on individual companies when I asked whether Paschi's recent disclosures might affect its assessment of the lender's viability.

So far, this feels like the rerun of a movie we've seen before. Back in 2017, with the blessing of the ECB and Brussels, Paschi received Italian funds that were meant to cover potential future losses stemming from a stress test. In reality, the new money covered existing weaknesses. The bank was probably insolvent at the time of the recapitalization, and should have been wound down.

In fairness, banks and their supervisors are still testing the complex set of rules put in place under the EU's Bank Recovery and Resolution Directive of 2013, designed to shield public funds after the bailouts of the financial and sovereign debt crises. Regulators also have to manage public perceptions when a deposit-taking bank is under strain, and avoid fanning concern that might deepen the lender's problems.

But if Italy is to avoid any doubt that it's playing by the rules, it needs to be transparent about how it's rescuing Paschi. To thrive, Europe's overbanked industry needs to become more integrated, with a common deposit-insurance scheme and the ability to move funds freely across the region. Keeping Paschi alive shouldn't become another reason for skeptics to resist a stronger financial union.

Elisa Martinuzzi is a Bloomberg Opinion columnist covering finance. She is a former managing editor for European finance at Bloomberg News.

Disclaimer: This opinion first appeared on bloomberg.com, and is published by special syndication arrangement.