MNI SOURCES: ECB Bank Resolution Concerns Amid Italy Nerves

--ECB Officials Fear Resolution Mechanisms Inadequate

     LONDON (MNI) - European Central Bank officials are increasingly concerned

that the eurozone's mechanisms for closing down failing banks are inadequate at

a time when Italy's clash with the EU over its budget plans has reawakened

concerns over the "doom loop" between lenders and public finances, ECB sources

told MNI.

     While the Bank Recovery and Resolution Directive (BRRD) was put in place in

2014, a move by the EU towards providing its Single Resolution Fund (SRF) with a

EUR60 billion backstop has yet to be finally approved and attempts to set up a

joint deposit guarantee system have been blocked by Germany. Concerns over the

size of banks' holdings of their own countries' sovereign debt also persist,

after proposals which would have forced lenders to hold capital against them

were dropped.

     Meanwhile, the continuing selloff in Italian government bonds is gradually

eroding the capital of the nation's banks, which are still dealing with more

than EUR250 billion in bad loans.

     --DOOM LOOP

     Italian bank shares fell heavily again on Friday, with Banca Monte dei

Paschi and Banco BPM both losing more than 5%, and Unicredit down more than 4%

by midday in Milan, as 10-year Italian bond yields rose to fresh four-year

highs.

     While the EU has dealt with banking crises in Spain and Ireland, the

prospect of a failure in Italy with inadequate resolution mechanisms is

disquieting.

     "Everybody agrees silently that in case of Italy, in case of a real big

player, resolution will not work, and cannot be done in the way intended," an

ECB source told MNI.

     While Italy's big banks are well-capitalised, officials are concerned that

some lenders might struggle to raise collateral in the case of a liquidity

squeeze, the source said.

     --ESM BACKSTOP

     EU ministers agreed in June to allow the European Stability Mechanism to

backstop the SRF with EUR60 billion, but final approval is still pending.

     "There are different proposals on the table, but politically it seems to me

that Germany and France are not willing to go a step further in providing

something," the source said.

     Meanwhile, Italian bank bailouts have already highlighted the limitations

of BRRD. The Italian government bailed out two smaller lenders in 2017 after the

EU's Single Resolution Board declared that they were not systemically important,

despite the European regulation's provisions for making bondholders bear the

cost of failures.

     The European regulations have removed previous national resolution tools,

but without substituting these with equivalent EU mechanisms, another ECB source

said.

     "Banks across the eurozone have become European only in the sense of a

European supervision, with a mayhem of often unclear banking rules," the second

source said. "The overlapping of supervisory organisms has made action less

resilient."

     "The original goal of the banking union, that of burden and risk sharing,

has been put aside due to growing mistrust among peer members. Such an ambitious

goal would have contributed in breaking the doom loop between banks and

sovereign debt, which persists," the second ECB source said, adding that

reserving EU resolution procedures for only systemically-important banks was

unfair.

     "Smaller non-systemic lenders are left with liquidation as ultimate measure

to address a crisis," the source said. "This not only stands as a step back in

the EU integration process, but it questions the whole project."

--MNI London Bureau; +44208-865-3829; email: Jason.Webb@marketnews.com

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