New Rules for Italy Banks “I’ll Guarantee Your Derivatives If You Guarantee Mine”

New Rules forItalyBanks "I’llGuaranteeYourDerivativesIfYouGuarantee Mine"

New Basel III rules require extra capital for derivative positions. Banks in Italy have already figured out a way around that rule.

Eurointelligence reports …

We have been on the watch-out for stories that government and central banks encourage banks to continue to act as buyers of last resort of government debt. Here is one from Reuters, according to which Italy is planning to circumvent the Basel III requirement that banks must hold more capital against derivative contracts through which they hedge their exposures on government bonds.

Reuters has the story that the 2014 budget includes a two-way guarantee whereby banks and the state guarantee each others’ derivative positions.


Reuters reports Italyplanstoofferguaranteesongovernmentbondderivatives

A new system of guarantees Italy is planning to introduce will make it cheaper for banks to negotiate derivative contracts with the Treasury over government bonds, potentially increasing their ability to buy Italian debt.

The move is linked to new Basel III international banking rules that require lenders to hold more capital against their exposure to derivatives contracts.

Under the new system, outlined in a draft decree linked to the budget law that parliament must pass by year-end, the Treasury and the banks will exchange cash sums on a short-term basis to guarantee their respective derivatives positions, based on their mark-to-market value.

The sums held as collateral will bear interest at money-market rates.

Eurointelligence comments …

There is nothing technically or legally appalling about the two-way guarantee of derivative positions, but it nevertheless cements the absurd inter-dependence of the Italian state and the Italian banking system. The eurozone crisis resolution policies critically depend on banks behaving as national players. Everything we see is geared towards the maintenance of this extremely unhealthy situation.

The leverage of European banks to their own sovereign debt is enormous. This mutual guarantee agreement encourages banks to continue the leverage party.

Another opportunity to rein in moral hazards just flew out the window. Every bank in Europe will do the same.

Mike "Mish" Shedlock

Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit to learn more about wealth management and capital preservation strategies of Sitka Pacific.

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