ECB Calls Italy's Bluff, Rejects Monte Paschi Request For More Time To Raise Capital

Earlier this week, we reported that according to the FT, a suddenly empowered Rome was demanding that the ECB give it more time to rescue Italy's Monte Paschi show private bailout effort has effectively failed. What is surprising is that Italy was "preparing to blame the bank for losses imposed on bondholders if Rome is forced into an urgent state bailout", a negotiating tactic we dubbed at the time blackmail.

The board of MPS, which has the Italian Treasury as its largest shareholder, was asking the supervisory arm of the European Central Bank to give it until mid-January to pull off a €5bn equity injection and try to avoid forcing losses on some debtholders as required under new EU bailout rules.  And this is where the blackmail came  in: cited by the FT, a person involved in the negotiations warned that “If they don’t give the extension, the ECB must take responsibility. They will be pushing the button. We are only asking for five more weeks.”

According to Reuters, as of moments ago the ECB has called Italy's bluff, and the central bank "has rejected a request by ailing Italian lender Monte dei Paschi di Siena for more time to raise capital, a source said on Friday, in a move that piles pressure on the Italian government to bail out the bank."

The ECB's supervisory board turned down the request at a meeting on Friday on the grounds that a delay would be of little use and that it was time for Rome to step in, the source said.

The news follows an earlier report according to which the head of the euro zone bailout fund said it was not preparing financial support for Italy though some individual Italian banks have problems and need to raise capital, the head of the fund said on Friday. Klaus Regling spoke two days after the Italian daily La Stampa reported that Italy was set to ask the ESM for a loan of 15 billion euros, quoting sources from the Treasury.

"We are not preparing anything. There are lots of rumors ... but this is not the case, we have not been approached by the Italian government (for help)," Regling told reporters in the Finnish capital Helsinki.

He said that Italy did not have a nationwide problem with its banking sector, despite the need of some individual lenders to raise more capital. "This is not at all like in 2009 or 2010 when we had several European countries with countrywide banking problems. Italy is not in that situation today," he said. "Banks are stronger; they have used the last few years to strengthen their capital."

He added that the ESM had instruments available to respond to any future emergency. "In theory, we are available to take capital in banks, to do direct banking capitalization. We supported the Spanish banking system in 2012. But again, this is not under consideration."

It may soon have to be.

As Reuters adds, the Italian government is expected to intervene to recapitalize the bank to avert the risk of it being wound down. The failure of Monte dei Paschi could threaten the savings of thousands of retail investors, ripple across the wider banking sector and provoke a financial crisis in the euro zone's third-biggest economy. Italy faces the risk of early elections, and the prospect of an anti-euro party coming to power, after Prime Minister Matteo Renzi quit this week following the heavy defeat of his plan to reform the constitution in a weekend referendum.