So, how might we get Deutsche Bank and Banca Monte dei Paschi di Siena in the same post? There seem to be two immediate options:

  • We could note that on Saturday a judge in Milan charged 13 former and current executives from Banca Monte dei Paschi di Siena, Deutsche (and also Nomura) over various matters, including whether derivative trades were structured to paint MPS’s balance sheet in a misleadingly flattering light.
  • Alternatively, we could look at whether both Deutsche and MPS might be trial candidates for a new form of bank resolution, namely the ‘temporary bail-in.’

It’s brilliantly simple: rather than force bondholders to step up when a bank sees its equity wiped out (as is supposed to happen in the current ECB resolution regime), bondholders will be asked to step in temporarily.

The core idea is to give management at a stressed but solvent bank both stability and time in which to organise a more thorough refinancing. Assuming the bank is able to raise fresh equity within a pre-set timeframe, the bailed-in bondholders would be given the option of swapping back from equity to debt. If the bank can’t find fresh capital, then the bondholders would be bailed-in for good.

The proposal comes from Adam Lerrick, a sovereign debt and bank rescue specialist at the American Enterprise Institute, who has come up with string of novel solutions to the thorniest eurozone debt problems over recent years.

Here’s his detailed paper on the matter.

The idea is certainly clean and just in that it avoids any state aid for a troubled bank, leaving taxpayers off the hook. This is essentially an extension of the notion of ‘contingent capital,’ which markets now seem pretty comfortable with.

But Lerrick is also suggesting a structure that protects retail bond investors, adapting an earlier proposal devised for Portugal’s hapless Banco Novo:

Small investors can be fully protected under a temporary bail-in while providing equal treatment for all investors of equal rank. EUR 200,000 of every investor’s debt holding would remain in its original debt form. Only the excess of each investor’s debt holding above EUR 200,000 would be temporarily converted to shares. For banks with large numbers of retail investors, 95% of retail bondholders will be completely protected from the temporary bail-in and keep their entire original debt claim.

Martin Wolf touches on the Lerrick plan in his latest take on the lengthy list of risks still facing the European banking sector, highlighted by last week’s Deutsche panic.

But the structure of the Lerrick plan — notably the protection of retail bond investors — should make this approach especially attractive to the Italian banking sector, which is looking more like the crisis-era Greek banking sector by the day.

And top of the list of Italian banks needing emergency recapitalisation is Monte dei Paschi. It’s still trying to find investors who might put up €5bn in fresh capital and, if the bank fails, quite a few ordinary citizens of Siena will be on the hook.

To date, the Italians have been arguing with the ECB and Germany over whether they might use a little-noticed power proposed under Article 32 of the EU Bank Recovery and Resolution Directive: namely, the temporary bail-out.

This is supposed to offer state-funded support for a troubled bank while fresh equity is raised. But we know from the aftermath of the 2008 crisis that temporary bail-outs of banks simply become permanent bail-outs. inviting private capital to flee.

The Italians have a chance to put themselves on the front foot here, implementing a solid private sector solution that treats all creditors pretty much equally and fairly.

MPS could even show Deutsche the way to go!

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