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25 January 2013 By Neil Unmack

Derivative blow-ups of the type that happened at Banca Monte dei Paschi di Siena are here to stay – even in the brave new world of the euro zone’s planned banking union.

It would be wrong to lay all the blame for Monte Paschi’s 720 million euro derivative loss on its regulator, the Bank of Italy. In the immediate aftermath of the scandal, many of the involved parties are trying to deflect blame onto each other, or plead ignorance. The central bank says it wasn’t shown key documents, and so couldn’t have known about the deals’ true purpose, which appears to have been to hide losses. The net effect was to push up the bank’s bailout costs by some 500 million euros.

When the single regulator comes on board, the European Central Bank will have substantial new powers. Then it must choose to use them. It will be able to limit a bank’s exposures, beef up governance, demand more public disclosure, and launch its own investigations. It can force banks to trim sketchy or risky businesses, and cut payouts to build capital.

But it would be naïve to think it will spot all the gremlins. For one, it will still rely on national regulators, who haven’t always been great at protecting their own backyard; think of the savings banks that brought Spain to its knees. Second, it will only have direct supervision over the 200-odd largest banks with 30 billion euros or more of assets. MPS will be in that bracket, but roughly 6,000 banks won’t. The risk is that the smaller banks become the next arena of regulatory arbitrage.

Finally, the ECB’s own track record of co-ordinating authorities across Europe isn’t spotless. Its own collateral framework has been the source of some embarrassing recent boo-boos when the venerable Banque de France got confused about the rules. The system won’t be perfect. The best hope is that it will improve.


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