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Individual essay: Otto Kannisto
Conflicts of interests: Italian banking sector and non-‐performing loans
According to the European Central Bank (2016) a loan is said to be non-‐performing when “more than 90
days pass without the borrower paying the agreed installments or interest.” Although non-‐performing
loans (NPLs) are normal part of banking business, for example it is often assumed that certain
percentage of loans will default, they can cause problems. From the viewpoint of the lender, such as a
bank, NPLs decrease profits since by definition it can’t recover payments from NPLs. If decrease in
lender’s profits is significant it will reduce its capacity to issue new loans. This in turn can hurt the
economy on whole since well functioning financial markets are a central part of modern society.
In Italy rising share of the NPLs brought on by economic downturn has caused major difficulties
for banks. Based on data by the World Bank (2016) share of bank NPLs to total gross loans in Italy was in
2015 almost eighteen percent whereas in 2007 it was under six percent. In monetary terms total
amount of bad debts in 2016 was 360 billion euro (The Economist, 2016, 61). This worrying development
and its negative effect to stock prices of Italian banks have forced stakeholders to confront the problem.
However, because of the magnitude of the debt problem and the systemic risks it poses there are many
parties of interest. These include: Italian banks, their customers and debtors, Italian government and
international authorities such as the European Commission (EC). With so many stakeholders there is
always potential for conflicts of interests.
Boatright (2014, 46) defines a conflict of interest as follows: “A conflict of interest occurs when a
personal or institutional interest interferes with the ability of an individual or institution to act in the
interest of another party, when the individual or institution has an ethical or legal obligation to act in
that other party’s interest.” To examine possible conflicts in case of Italian NPL problem I will outline
solutions put forward by stakeholders and discuss the different obligations that these stakeholders
have. I will start with bailout plan devised by Italian banks themselves.
One way to deal with NPLs is to sell them. But who would buy them and at which price? To
answer these questions Italian banks and other institutions motivated by looming financial collapse
agreed to set up a fund called Atlante. The sole purpose of Atlante is to buy bad debts from banks and
thus alleviate their financial situation. Among participants to Atlante is state controlled Cassa Depositi e
Prestiti (CDP). Independent asset management company Quaestio Capital Management is managing
Atlante and no single shareholder is allowed to have majority. According to the Economist (2016)
aforementioned features may cause problems: for example which banks should be saved and is CDP
involvement in accordance with the Eurozone rules.
There are several potential conflicts of interests in Atlante. Here the word potential refers to
Boatrights (2014, 47) definition in which he draws a distinction between actual and potential conflict of
interest main difference being that actual conflict of interest is acted upon whereas potential conflict of
interest is likely to occur but may not translate to action. Because there is no majority ownership
managers of the Atlante fund face impersonal conflict of interest that is sometimes described as “two
masters” problem. For Atlante manager there aren’t necessary personal gains to be achieved by
choosing certain NPLs to buy over others but for their clients there are. Therefore when deciding which
NPLs to buy, managers have to choose which of their clients are most important. This is a potential
impersonal conflict of interest.
Altante and especially CDP’s involvement in it is also problematic for European regulators. On
the one hand creation of Atlante is move towards stabilizing the Italian economy. This is beneficial for
the European Union and should be therefore encouraged. But on the other hand it can be argued that
state intervention via CDP gives Italian banks an unfair advantage against their European counterparts.
In short the question for European authorities is which of the interests is more important: fairness of the
system or the stability of the system?
In addition to Atlante there are other parties interested in buying NPLs. One of these is KKR and
its platform called Pillarstone. The Economist (2016, 58) states that Pillarstone aims to combine
corporate restructuring with loan management for banks. Although Pillarstone’s approach may be novel
it also introduces potential for conflicts of interests. As in the case of Atlante management this conflict is
potential and impersonal by its nature. Pillarstone may have to choose between the interests of
company it has taken over and bank which loans it manages and that has lend money to the company
taken over. For example it is in banks’ interest to receive payments as soon as possible whereas for the
corporation taken over by Pillarstone paying back loans as fast as possible might not make sense if there
are other options available.
One might ask why bother with NPL funds and management companies? Why not just bail out
the Italian banks? After all using taxpayers’ money to save struggling bank is hardy an unusual solution
these days. According to the Economist (2016, 59) one reason why Italian government is hesitant to bail
out troubled banks is the new and stricter policy of the European Commission. The new policy aims to
cut down government bailouts by introducing mandatory bail-‐ins. In practice this means that if a bank
receives government money its shareholders and creditors are forced take on some losses. To be exact
the new EU Bank Recovery and Resolution Directive or BRRD (European Commission, 2014) states: “In
circumstances of very extraordinary systemic stress, authorities may also provide public support instead
of imposing losses in full on private creditors. The measures would nonetheless only become available
after the bank's shareholders and creditors bear losses equivalent to 8% of the bank's liabilities and
would be subject to the applicable rules on State aid.“ The directive’s goal is to reduce moral hazard that
arises when a bank becomes “too big to fail”. But even if BRRD is justified it has caused some ethical
dilemmas because in Italy many of these creditors are regular citizens who happen to be bondholders
and can’t afford to lose the value of their investments.
In the heart of the problem lies the question of asymmetric information and its ethical
implications. Were the regular bond-‐buying citizens aware of the risks and if not who’s fault is it? To
make matters even more convoluted there have been allegations of banks purposely misleading their
customers. For example Italian lawyer Floro Bisello states in Bloomberg interview (2016): “Many of my
clients are factory workers, pensioners, who lost all the savings they had. Some of them were told that
investing in subordinated bank bonds was just a way to earn higher interest, but just as safe as investing
in Italian government bonds.” Here it should be noted that Bisello’s description might not represent the
full picture. In fact Bloomberg (2016) analysis shows that households owning bank bonds are on average
twice as wealthy as national average, i.e. not poor pensioners or factory workers.
To further our investigation to Italian bond selling I will introduce aspects of ethical theory. In
field of the financial activities at least two distinctive ethical systems can be applied. One of these is
utilitarianism: a philosophy stating that moral worthiness of action is determined by its effect on total
happiness (Posner, 1979, 104). To a utilitarian action is ethical if it produces more happiness than pain.
This is also the idea behind vast economic theory originating from a concept of the utility function.
Question for the utilitarian is if the selling of bank bonds to regular citizens produced more happiness
than pain. This is an impossible question since neither can be measured and we can’t know how many
people were affected. By the latter I am referring for example to the widely reported suicide of a
bondholder who lost his saving. In his case simple transaction of money to bonds eventually caused
suffering not only to him but also people around him. Even if utilitarian question cannot be truly
answered one would venture to guess it to be unlikely that selling of the bonds produced so much
happiness that it outweighs pain which follows if these bonds, previously believed to be safe
investment, lose their value.
Besides utilitarianism, theory of discourse ethics can be applied. To fully describe discourse
ethics is beyond this essay but some generalizations can be made. Discourse ethics is a theory that
emphasizes role of the interpersonal communication. In discourse ethics valid norm is product of a
thorough argumentation between parties involved (Gilbert & Rasche, 2007, 190) or as Habermas (1999,
42) puts it "A norm is valid when the foreseeable consequences and side-‐effects of its general observance
for the interests and value-‐orientations of each individual could be jointly accepted by all concerned
without coercion." There is naturally much more to the discourse ethics but for our case this is already
enough. For example, act of selling a bond is not a norm but we can translate it to a norm such as “a
bank should be able to sell risky bonds to all customer.” Inspection of this ad hoc norm reveals couple
interesting points. First: buyers of the bonds were not coerced. This is in accordance with discourse
ethics. But were the foreseeable consequences jointly accepted? Now we arrive to the points of
asymmetric information and claims of dishonesty mentioned earlier. If the buyers were not aware of the
consequences but sellers were it could be argued that actions committed by sellers were unethical and
ethically valid conclusions via discourse were not reached. In fact according to Reuters (2015) there has
been high-‐level political discussion about banning the sales of bank subordinated debt to retail
For Italian government in general the conflict of interest is potential and impersonal but for the
person in charge meaning Prime Minister Renzi there is also a personal component in the problem. In
theory, the conflict is impersonal for the Italian government because they are operating under pressure
from two opposing side: the European authorities and bondholding Italian citizens. If the government is
eventually forced to bail out banks it will have to choose whether to respect BRRD and cause harm to
Italian bondholders or whether to not respect it therefore undermining the European unity. For PM
Renzi siding with bondholders would be beneficial since these bondholders and people around them are
part of the voting population from which Prime Minister derives his mandate.
According to Financial Times (2017) securisation of NPLs has continued and share of them is
likely to drop in in 2017. However, it is not yet clear how much demand there will be. Italian government
is trying to boost NPL market by providing guarantees for some of these securities. From the perspective
of conflict of interest presented in previous paragraph this can be seen as a rational move. By backing up
the market oriented solution government can avoid the conflict of interests that arises if a bailout is
To summarize there are many conflicts of interest interwoven to Italian NPL crisis. Most of these
are potential and impersonal as is often the case in world of finance. Have these conflicts influenced
decision-‐making? Only the people making decision know for sure. For the outside observer it seems
probable: managers of Atlante and other NPL funds are forced to choose between competing interests
of their customers. The same applies to Italian government but instead of customers it may be forced to
choose between interest of Italian people and European regulators.
In addition to conflicts of interest there are some morally ambiguous elements in the Italian
NPLs case that make it even harder to solve. By this I mean that to use the relative simple solution of
bailout Italian government would most likely be forced to punish people who may have been treated
unethically by the same banks Italian government aims to save.
Boatright, John R. (2014), Ethics in Finance, 3rd edition. USA, Wiley Blackwell, 46–49.
Bloomberg, 22.12.2016, Bank Bondholders Italy Aims to Protect Are Not All That Poor,
Bloomberg, 28.6.2016, Households on the Hook for Italy’s Next Bailout,
European Central Bank (2016) What are non-‐performing loans (NPLs)?
European Commission (2014) EU Bank Recovery and Resolution Directive (BRRD): Frequently Asked
Questions < http://europa.eu/rapid/press-‐release_MEMO-‐14-‐297_en.htm>
Gilbert, Ulrich & Rasche Andreas (2007) Discourse Ethics and Social Accountability: The Ethics of SA 8000
Business Ethics Quaterly, vol. 17. 187–216.
Habermas, Jürgen (1999) The inclusion of the other: Studies in political theory. Cambridge MA:
Posner, Richard A. (1979) Utilitarianism, economics, and legal theory, Journal of Legal Studies, vol. 104.
Reuters, 18.12.2015, Arrivederci for Italian retail sub debt?
The Economist, 16.4.2016, A heavy load, 61–62.
The Economist, 20.8.2016 , Bargain Hunt, 57–58.
The Economist, 9.7.2016, Crisis and opportunity, 59–60.
The Financial Times, 30.1.2017, Securitisations of Italian NPLs set to rise in 2017 – Moody’s
The World Bank (2016) Bank nonperforming loans to total gross loans (%)
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