VZCZCXRO0312
RR RUEHFL RUEHNP
DE RUEHRO #0259/01 0640900
ZNR UUUUU ZZH
R 050900Z MAR 09
FM AMEMBASSY ROME
TO RUEHC/SECSTATE WASHDC 1715
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHMIL/AMCONSUL MILAN 9891
RUEHNP/AMCONSUL NAPLES 3676
RUEHFL/AMCONSUL FLORENCE 3501

UNCLAS SECTION 01 OF 02 ROME 000259 
 
SENSITIVE 
 
SIPDIS 
 
TREASURY FOR OIA VIMAL ATUKORALA 
 
E.O. 12958: N/A 
TAGS: ECON EFIN IT
SUBJECT: Italy Implements Measure to Bolster Bank-Lending. 
 
REF:   08 ROME 001489 
 
¶1. (SBU) Summary -- On February 26, the GOI authorized the Italian 
Treasury to buy extraordinary convertible bonds issued by Italian 
banks as a way to raise banks' capital ratios and spur new lending, 
especially to small and medium businesses. The instruments, in terms 
of risks taken by the GOI and Banks' obligations, are closer to 
shares than bonds, and as such will count in Tier 1 capitalization 
ratios.  Conditions for banks to issue such bonds include allowing 
the government to monitor bank lending, providing mortgage relief to 
certain borrowers, limiting executive compensation, and refraining 
from paying dividends. Banks deny there is a credit crunch in Italy, 
but might, for political and appearances' sake, participate to a 
limited extent in the program. The GOI's measure appears consistent 
with other major economies' efforts to revive lethargic credit 
markets. End Summary 
 
¶2.  (U) On February 26, Economy Minister Giulio Tremonti signed a 
decree allowing the Italian Treasury to buy extraordinary 
convertible bonds issued by Italian banks.  The so-called Tremonti 
Bonds are special financial instruments convertible to equity 
shares, and as such, contribute to Tier 1 capital. While bearing an 
annual yield of between 7.5% and 8.5%, the bonds' face value will 
vary with banks' capitalization ratios; if bank capital grows, so 
will the bonds' face value. If bank capital falls, bonds' face value 
will fall.  The bond measure, which the government had outlined in 
November 2008 as part of its general stimulus package (reftel), was 
prompted by a GOI concern that the economic slowdown has driven 
banks to cut back lending, especially to small and medium 
businesses, thus exacerbating the recession in Italy. 
 
¶3.  (U) In order to prevent these funds to simply bolster bank 
balance sheets with no positive impact on the "real" economy, the 
government conditioned issuance of the bonds on a broad agreement 
between Italy's banking association and the Ministry of Economy and 
Finance.  The proposed agreement would require banks to keep up 
loans to small- and medium-sized firms and households, to provide 
mortgage relief to people receiving unemployment benefits or on 
part-time layoffs, to limit salaries and bonuses for bank 
management, and to commit not to distribute dividends to 
shareholders.  Most remarkably, participating banks would have to 
agree to a government-appointed banking "prefect" to monitor their 
loans for socioeconomic merit. Before approving any bond issue, the 
Bank of Italy will review each applicant bank's capital structure 
and risk profile. 
 
¶4.  (U) Tremonti in November outlined the program ranging from 10 
to 12 billion.  The government intends to finance it with a mix of 
modest spending cuts, re-directing unspent funds of public 
institutions and issuing new government securities that supposedly 
will have a limited or negligible impact on public debt or the 
deficit. 
 
¶5. (SBU) Banks contend that they have little need for these 
securities and that there is no credit or liquidity crunch in Italy. 
 Any slowdown in credit flows, they maintain, is due to dropping 
demand for loans (one Milan bank told econoff that of euro 500 
billion in credit lines outstanding, clients have used only 370 
billion).  While this may be technically true, small and medium 
firms complain that the reason for the drop-off in demand is that 
interest rates remain too high. Indeed, Italian banks have 
maintained the fat 400 basis-point margin between cost of funds and 
average loan rates that they enjoyed prior to the October 2008 
meltdown.  Italian banks fund themselves approximately one third 
from checking accounts (whose average interest rate is 0.5%), one 
third through the interbank market (at rates ranging from 1.7-1.8%), 
and the remaining third from bonds.  Moreover, one fifth of Italy's 
gross national income is saved every year, a rate that is among the 
highest in any advanced economy, equal to about 10% of disposable 
income. This means banks have a huge flow of funds available at very 
modest interest cost, averaging just under two percent. 
 
¶6. (SBU) Comment:  The measure seems designed, like earlier ones, to 
bolster the Italian public's confidence in the banking system, while 
at the same time demonstrating the Italian government's will to 
compel the financial sector to throw in its lot with ordinary 
Italians struggling to overcome the recession.  In addition, the 
terms of the bonds seem designed to entice other private 
institutions to invest in banks (a provision requires that 30% of 
the bond issue be subscribed by private entities). So far, the 
government can point to just one un-named bank (very likely the 
Banco Popolare network) coming forward to take part in the plan. 
Italy's largest banks (Unicredit, Intesa-San Paolo, Monte dei Paschi 
di Siena (MPS), Banco Popolare and UBI Banca) have not yet announced 
their intentions, but press commentators speculate that Unicredit 
and Intesa San Paolo may request 3 billion each, while MPS could 
 
ROME 00000259  002 OF 002 
 
 
apply for 1.5 billion.  Whether Banks will participate and to what 
extent will probably depend more on banks' perceived need to be seen 
to collaborate with the government, than on actual weakness in their 
capital structure. What will likely give banks the greatest pause is 
the notion of having yet another government overseer second-guessing 
their decisions and possibly pressing them into imprudent loans. 
Individual banks could announce their intentions by week's end. 
Dibble