The Italian government is likely to put in about €6.5 billion to rescue the country’s third-biggest lender Monte dei Paschi di Siena, more than initially expected, sources close to the matter said.

The Italian lender needs about €8.8 billion of capital to bolster its balance sheet, the European Central Bank (ECB) said, up from previous estimates of €5 billion.

The calculation is based on the results of a 2016 stress test, the bank said in a statement late Monday, citing two letters from the ECB that it received via Italy’s finance ministry.

While the ECB saw worsening liquidity at Monte Paschi in December, it still considers the Italian bank to be solvent because it meets tier 2 capital requirements. (Under capital adequacy regulations meant to ensure banks keep enough money on hand, tier 2 capital is supplementary capital that is more complex and variable such as loan loss provisions and subordinated debt). Paschi is seeking further information on the central bank’s calculations, according to the statement.

On Friday, the Italian government said it would put as much as €20 billion into Monte Paschi and other banks after the lender failed in its plan to raise about €5 billion from private investors. Chief executive Marco Morelli had travelled the world looking for investors to back the bank's reorganisation plan, which included a share sale, a debt-for-equity swap and the sale of €28 billion of soured loans.

Liquidity deterioration

Il Sole 24 Ore reported Tuesday that the Italian government will invest €6.3 billion in the bank, after the newspaper said Monday that the European Central Bank had called for a €4.5 billion contribution from the Italian state and €4.3 billion from bondholders.

In a statement, Monte dei Paschi also revealed that the ECB had warned that the bank’s liquidity had suffered a “rapid deterioration” over the past month, as it had tried in vain to muster enough cash from private investors to avoid a state bail-out.

The worsening capital and liquidity position at MPS marks a new twist in a long-running saga surrounding the fate of world’s oldest bank, which has arguably emerged as the weakest link in the Italian and European banking system.

Monte dei Paschi will now consume more of the Italian bank rescue money than previously thought: on Monday, the ECB sent a letter to the Italian finance ministry to inform it that Monte dei Paschi capital shortfall was now €8.8 billion, compared to the €5 billion it was estimated to need in the aftermath of July’s Europe-wide banking stress tests.

But the higher price tag for Monte dei Paschi will potentially give it less leeway to cover possible rescues of other smaller regional Italian banks which have been suffering from similar problems, even though Italian officials have insisted that there is ample room in the €20 billion already approved.

One person close to the situation said that the higher capital shortfall was driven by the gloomier liquidity position at Monte dei Paschi.

Net liquidity

Although the Tuscan bank is solvent, the ECB told the Italian finance ministry that its liquidity position had suffered from a “rapid deterioration” between November 30th and December 21st, crucial weeks for its private capital raising effort. During that period, net liquidity at one month declined from €12.1 billion, or 7.6 per cent of its activities, to €7.7 billion, or 4.8 per cent of its activities.

One Italian official also said that once a government intervention was introduced, there was a change in the way capital shortfalls were calculated by the ECB, increasing the amount.

Rome intends to structure the MPS rescue as a “precautionary recapitalisation”, which applies to banks which are still solvent but require capital to meet regulatory standards in the event of a deep recession. The scheme involves a much less drastic hit to investors in the bank than is the case under EU rules if a bank goes into resolution, when even depositors over €100,000 can be “bailed in”.

But the MPS bail-out has also faced a political backlash from some politicians and officials in Berlin who believe that the bank should be wound down instead.

Jens Weidmann, president of the Bundesbank, Germany's central bank, said in an interview with Bild newspaper that the MPS bailout needed to be "carefully examined". "State funds are only intended as a last resort, and that is why the bar is set high," he said.

– (Copyright The Financial Times Ltd 2016, Bloomberg, Reuters)