Monte dei Paschi di Siena-The Reasons Behind the Problems of the World Oldest Bank

BANCA MONTE DEI PASCHI DI SIENA
The Reasons Behind the Problems of the World Oldest Bank
Babuin Andrea, Giacomelli Dario, Kejemto Armel, Sivero Mario, Zilio Andrea
May 2016
Abstract
This paper provides a brief modern history of Monte dei Paschi di Siena, trying to explicate the
reasons behind the distresses the bank is facing. After introducing the oldest financial institution in
the world still operating, we focus our attention on the operations it carried out in the first years of
the new millennium (emphasising in particular the Alexandria Affaire) underlying the criticisms,
the risks and the lack of economic rationality of the products MPS decided to acquire.
We then focus on the role of the Italian and European supervisory authority in preventing and
solving the problems the Italian bank created to itself and to the Italian banking system as a whole.

Babuin A., Giacomelli D., Kejemto A., Sivero M., Zilio A. May 2016
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1. Introduction: A brief history of the oldest surviving bank
Banca Monte dei Paschi di Siena S.p.A. is the oldest surviving bank in the world and Italian third
largest commercial and retail bank by total assets, according to a research from “Ricerche e Studi”,
using 2014 data.
Founded in 1472 under the name of “Monte Pio” by the magistrate of the city-state of Siena, as a
“mount of piety”, it has been operating ever since and it is therefore considered the oldest bank in
the world still operating. As all the Mounts of Piety founded in those years over the Italian territory,
Monte Pio was not organized for speculation, indeed the money collected were paid out for
welfare’s aims with low or null rates.
In 1568, because of the growing importance of the institute in the local economy, the statute of the
company was reformed and Monte Pio became the first lending institution with the aim to support
the public foundations. An institutional role has been given to the company in 1580, confirming the
position of public bank with the role of ensure the collection of the taxes over the territory of
Maremma.
Its current form dates from 1624, when Siena was incorporated in the Grand Duchy of Tuscany and
the Grand Duke Ferdinando II granted to depositors of Monte the income of the state-owned
pastures of Maremma (the so-called “Paschi” which gave the bank its name). Consequently, Monte
dei Paschi di Siena became the competent authority on the territories of Siena and Maremma.
During the 17th and 18th centuries, the bank experienced many structural and institutional changes
also because of different historical events that affected the Grand Duchy of Tuscany. Especially in
1833, a measure emanated by the municipality of Siena ratified the creation of a Saving Bank,
which supported the agricultural and commercial development of Siena’s territory and succeeded to
hold up all the Tuscan territory until the unification of the Italian territory.
With the unification of Italy, the bank expanded its business throughout the Italian peninsula,
initiating new activities, including mortgage loans, the first experience in Italy.
In 1910, Monte dei Paschi represented one of the most important national banks in spite of the
Italian historical problem, since it was the second institution with nature of Saving Bank.
After the First World War, Monte dei Paschi consolidated its presence on the Italian territory by the
acquisition of Credito Toscano and of Banca Toscana. MPS was also involved in the bail-out of
Cassa di Risparmio di Prato, becoming the major shareholders.
In the midst of the global financial crisis, in 1936 the Italian legislator decided to give to the Italian
banking sector a structure by emanating the “banking law” of ’36. In this context, Monte dei Paschi

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was undertaken under the control of the State and it will remain under it until the accession to the
European Union by Italy, whereby the government had to align its national rules with the principles
of free competition. Consequently, in 1995 by a decree of the Ministry of the Treasury of the
Italian Republic, dated 8 August 1995, Monte dei Paschi di Siena was subject to the process of
renewal of the Italian Credit Sector, being subdivided in two separate units: “Fondazione Monte dei
Paschi di Siena”, a non-profit organisation that provided the territorial, social and cultural
development, and “Banca Monte dei Paschi di Siena”, whose task was to generate profits by its
banking activities operated over the whole Italian territory.
After the Second World War the growth of the institution was carried on, also internationally. The
major acquisitions made in those years were: “Credito Lombardo” in 1976, then sold to the Banca
Antonia-Popolare Veneta; “Credito Commerciale dell’Italmobiliare” and “Italian International
Bank” of London, in 1979; “ICLE”, “Cariprato”, “Banca Atlantis” and “Mediocredito Toscano” in
1992. In 1997, MPS acquired also the 5% of “San Paolo IMI”.
On 25 June 1999, Banca Monte dei Paschi di Siena was listed successfully in the Italian Stock
Exchange and this success led to a further strategic and operative reinforcement for the institution.
Indeed, after its debut on the Italian Stock Exchange, the bank began an intense phase of
commercial and operational expansion. The bank acquired some regional banks: “Banca Agricola
Mantovana” and “Banca del Salento”. In 2003, the controlling interests (79%) of “Cassa di
Risparmio di Prato” was sold to “Banca Popolare di Vicenza” in March 2003 for €411.2 million.
At the same time the bank upgraded its commercial productivity, with the aim of improving the
level of assistance and consultancy to investors and businesses and updated its activities in Private
banking and in Private pension plans. At the conclusion of this plan of expansion, the bank
implemented a vast program of opening new branches of the Group, with more than 2000 branches
over the Italian territory, becoming the third national banking group, following “Unicredit” and
“Intesa San Paolo”.
Finally yet importantly, in the beginning of the new century, the finance sector of the bank started
to follow the market trend in structured products, betting in derivatives which will cause huge losses
to the Italian bank.

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2. Speculating through derivatives: a dangerous approach
Since the beginning of 2000s, following the program of expansion and internationalization of the
bank described so far, Monte dei Paschi di Siena started some unusually hazardous and risky
operations in complex and opaque structured products, which were going to expose the bank to
huge losses during the financial crisis of 2008 and the European sovereign-debt crisis of 2011.
Given also the acquisition of “Banca Antonveneta” in 2008 at an absolute unfair price, some say
more than double of the real value [Bloomberg, 2013], the balance sheet of MPS could not survive
the market’s turmoil that shocked the economy.
There have been three main operations, subscribed with foreign important financial institutions that
have been, and still are, under severe investigation of Italian and European supervisory authorities
and of the bank itself.
In the next pages we will have a brief insight on two of them, Corsair (Note Italia) and Santorini,
and a deeper focus on Alexandria, the more complex and famous scandal the bank experienced in
the past years.
The first of these three operations is “Santorini”, subscribed with Deutsche Bank (DB) in 2002.
MPS buys for € 328.69 million participation at 49% in “Santorini Investment Ltd Edinburgh”, an
SPV (Special Purpose Vehicle, whose operations are limited to the acquisition and financing of
specific assets), selling at the same time to DB the 4.99% quota of Sanpaolo IMI (Intesa Sanpaolo
after 2007) for € 785.4 million (the book value is, in 2002, € 1210.7 million). [BMPS balance Sheet,
2002].
In the end, Santorini enters with DB in a Total Return Swap (TRS1
) on Sanpaolo IMI: The SPV
pays a fixed rate of 5.025% plus the losses on the reference asset (Sanpaolo IMI shares), while
receiving from DB the dividends plus the gains of the Sanpaolo shares.
The product then passes through a series of renovations:
In 2006 MPS becomes 100% proprietary of “Santorini”, with some parameters modified (fixed
exchange rate lowered at 3.3%). MPS’ CFO declares that “the risk for the bank is unchanged”;
1
A swap agreement in which one party makes payments based on a set rate, either fixed or variable, while the other
party makes payments based on the return of an underlying asset, which includes both the income it generates and
any capital gains. In total return swaps, the underlying asset, referred to as the reference asset, is usually an equity
index, loans, or bonds, owned by the party receiving the set rate payment.

5
In 2008, to mask losses in MPS’s balance sheet due to Santorini exposition at the huge stock market
collapse (losses greater than € 300 million, according to [Bloomberg, 2013]), MPS enters for € 2
billion in an asset swap2
with DB on BTP-18 and 20 (18, 20 year-end of the bonds). This operation
is funded with a penalizing Long-Term Repo for MPS, which not included in VaR3
computation the
riskiness of this new agreement (including it in the VaR raised it of about 30%) [Ispezione
Cantarella, 2010]. At the same time, Santorini enters in an Asset Swap with DB with the same
notional amount. The aim of these operations appears to be to spread the huge losses of the TRS in
a long period of time, avoiding in this way to account for them in the 2008 income statement of the
bank. This strategy looks similar to the one applied, in a more subtle way, renovating another
stressed derivative product, Alexandria;
In mid-2009 MPS liquidates Santorini for € 224.4 million and substitutes the Asset Swap with one
on BTP-31 (extending the duration of an already penalizing borrowing);
In December 2013, due to a general restatement of past distressed operations, more costs for €
428.9 million relative to Santorini are taken into account in the income statement [MPS Press
Presentation, 2013].
The second operation is Corsair (name of the Irish SPV involved), subscribed in 2006 with JP
Morgan.
MPS buys € 500 million gaining USD Libor 3m + 0.2425% until 2037 (extremely long maturity,
linked to BPT - 2037). The underlying of the notes subscribed by the Italian bank are Spanish and
American public sector mortgages.
The operation involves many risks, as Santorini and Alexandria: MPS is the only buyer
(concentration risk), JP Morgan is the only counterpart (counterparty risk) it has a currency
exposure to EUR/USD exchange rate (currency risk), the mortgages were all but safe (reference
entity risk) as the financial crisis will show to the world.
As reported by an audit risk report of 20094
, if the Finance Sector invested directly in BTP 2037
instead of Corsair, the profitability of the trade would have been 400% higher; thus, the economic
2
An asset swap package involves transactions in which the investor acquires a bond position and then enters into an
interest rate swap with the bank that sold him the bond. The investor pays fixed and receives floating. This transforms
the fixed coupon of the bond into a Libor/Euribor based floating coupon.
3
A measure of the maximum losses a portfolio of positions can suffer, given a certain confidence level and a limited
time horizon
4
http://www.lettera43.it/economia/economiaweb/nota-italia-una-credit-note-da-500-mln_43675194568.htm

6
rational of the operation is absolutely not clear, but the effects on the balance sheet of MPS are still
unknown.
In the end, we have the third main operation, Alexandria, the most intricate and famous among all
the manoeuvres of the Italian bank.
As we already anticipated, a similar story of Santorini and Corsair applied to this derivative, a way
more complicate product bought in 2005 by MPS from Dresdner Bank (acquired in 2009 by
Commerzbank). At that time "playing with derivatives" was in fashion, all the major banks used to
do it and MPS decided to invest € 400 million in Alexandria.
The operation involves four companies: The banks Dresdner and Monte dei Paschi, and two SPV
based in Dublin, Alexandria Capital plc (from which the name of the derivative subscribed) and
Alchemy Capital plc.
The core of Alexandria is Skylark ltd, a Cayman based company, which receives cash flows from a
portfolio of Asset-Backed-Securities (code name: Madison).
What is an Asset-Backed-Security (ABS)? The creation of an ABS is the operation where a
company removes a series of receivables from its balance sheet, appropriately “parcels them up”
and assigns them to the market via the SPV, together with the financial flows they generate, with
the aim of creating liquidity. They are in all respects similar to ordinary bonds: they pay the holder
a series of coupons at set maturities for an amount calculated based on fixed or variable interest
rates.
MPS buys then € 400 million of notes issued by Alexandria Capital Plc (€260 million from
Dresdner and €140 million form a South-Korean broker, Coryo. It is not clear why this
intermediation was necessary), which pays to the Italian bank euribor 3m + 0.8%. The notes were
linked to Skylark ltd and the cash flows received from the ABS portfolio. Around this structure was
developed a system of cash flows between the other parties involved (Dresdner and Alchemy with
Alexandria and Skylark). It is difficult to understand the ratio underlying all the operations around
the main agreement between Dresdner and MPS (see illustration in the appendix).
MPS was not even able to determine the value of this product. The only “price” available was the
one computed by Dresdner in 2005, during the creation of the structure. In the Sentence of the
Court of Siena, page 82, the Risk Manager Conti Giovanni clearly exposes that given the opacity of
the structured products traded in the finance sector of the bank, the risk management office was not
able to determine a price, and then a risk measure, for derivatives such Alexandria.

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Witness statement (Conti Giovanni, translated): “…I would like to explain what it means ability of
pricing… It is necessary to know exactly the risk factors affecting traded products… [ ] products
bought by the finance area were not transparent products. Thus, for me, who I cannot even talk
with counterparties, it was even impossible to create an algorithm to price them (and Alexandria is
one of them)… [ ] For example, Pitagora’s Theorem is extremely easy, but if I do not have one of
the two sides of the triangle, I cannot find the hypotenuse… [ ] Alexandria was a Chinese Box,
made of many pieces. It was a bond with collaterals mixed among them. If I do not know this
structure, I have to take the price the counterpart tells me… [ ]”
This kind of operation, and the same rules apply for the other described, involves all the main risks
a bank has to face off while operating:
 Credit Risk: Dresdner has an A rating from S&P [MPS Affaire, 2013] and it is the only
counterparty in the deal (counterparty and settlement risk high). According to the insight
provided by QFinlab presentation in 2013, Madison had an AAA rating from S&P, not
explicable given the rating of the only counterpart and the rating of the ABSs underlying the
product (not AAA).
 Market Risk: As already explained, MPS was not able to make a price for the product (Price
Risk).
 Interest Rate Risk: the derivative payoff was determined by the euribor fluctuation, exposing
in this way the bank to the IRR.
 Liquidity Risk: The underlying of the product did not have any secondary market.
 Operational Risk: it can be defined as the risk of monetary losses resulting from inadequate
or failed internal processes, people, and systems or from external events5
. Given the
structure of Alexandria described so far, also this risk appears significant in this kind of
operation.
With the spread of the financial crisis in 2008, Madison notes faced a potential loss of €220 million;
worried about the economic and reputational costs of such an event for the bank, MPS decided to
restructure the entire product. After failing two deals with Credit Suisse and JP Morgan, the Italian
bank signed an agreement with the Japanese bank Nomura.
The renovation consists in substituting the Madison Notes underlying Alexandria with other notes,
named Aphex, issued by Aphex Capital plc. There are no information about the structure of these
notes, presumably their underlying is safer than the Madison’s one.
5
http://www.frbsf.org/economic-research/publications/economic-letter/2002/january/what-is-operational-risk/

8
At the same time, MPS buys for € 3.05 billion an asset swap package with the Japanese bank on
BTP – 2034 at euribor + 0.98%. The operation is financed through a “Long Term Repo6
” at euribor
+ 0.59% collateralized at 115%. In the end, MPS provides a liquidity facility to Nomura at euribor
+ 0.5% collateralized at 105% (see the appendix for a graphical representation).
How do the risks change due to this product’s renovation?
The credit risk switches to the Italian debt’s solvency. The structure implemented, involving BTP
with 25 years of maturity, can be summarized as a synthetic CDS on the Italian Republic.
Moreover, given the size of the operation and the presence of only one counterpart, the
concentration risk is still high.
Furthermore, buying € 3.05 billion of BTP 2034 in an auction of € 21 billion (with an almost not-
existent secondary market) creates huge problems for the liquidity of the bank, as Bankitalia
pointed out in his reports.
What was the reason behind the MPS decision to enter in such a complicated and potentially
dangerous operation? The main reason is the reputational cost Alexandria was representing for the
bank. In that period (2009), the subprime crisis caused an unprecedented financial distress, and the
potential losses of this instrument scared the managers of the Italian bank. As a consequence, they
tried to avoid this situation “hiding” the costs of Alexandria inside the agreement with Nomura. In
that way they could amortize the payment made to Nomura over the time period of the Long Term
Repo discussed, not indicating in the income statement the huge damages the bank was going to
incur into.
Last but not least, hiding one part of the mandate agreement subscribed with NOMURA pumped
up all the risks described so far, increasing the reputational and economic costs of the already under
pressure Italian bank.
The mandate agreement represented the unique signed agreement between the parties involved,
MPS and Nomura, which proved the economic and legal link within the Alexandria restructuring
and the BTP 2034 operation. As a matter of fact, the agreement had an indisputable patrimonial and
financial value for the supervisory authority point of view, because it could be included in the
6
A sale (and) repurchase agreement, also known as a repo, is a transaction concluded on a deal date t between two
parties A and B. In a repo agreement the party B acts as a lender of cash, whereas the seller A is acting as a borrower
of cash, using the security as collateral. Almost any security may be employed in a repo, though highly liquid securities
are preferred as they are more easily disposed of in the event of a default. More importantly, they can be easily
obtained in the open market where the buyer has created a short position in the repo security by a reverse repo and
market sale; by the same token, non liquid securities are discouraged.

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income statement as a negative component, altering the real situation of the bank. Indeed, the
bank’s manager involved in the scandal, hid this document, with the aim to keep the REPO
operation separate from the restructuring of Alexandria while the agreement was affecting the fair
value of the BTP 2034 operation, which, in the absence of an active market, also incorporated the
remuneration of Nomura for the substitution of the Skylark Notes with the Aphex ones (Alexandria
underlying).
Furthermore, the Mandate Agreement was significant for the risk undertaken by the bank in this
structure: there was a huge liquidity risk due to the obligation, in case of unreached agreement, for
the Sienese bank to buy asset swaps of a 5 year longer duration (and thus riskier).

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3. The role of supervisory authorities
The supervisory activities conducted by the Bank of Italy in recent years with regard to Monte dei
Paschi di Siena have been continuous and of growing intensity, with a focus on the main areas
crucial for its management: capital adequacy, the prudent management of the liquidity position,
financial risks and, in particular, interest rate risk, the dynamics of the large holdings of mainly
long-term Italian government bonds, credit quality, the verification of internal models for measuring
credit and operational risk, and the adequacy of management and of the system of internal controls.
According to the operative relations Bankitalia produced, the following pages provide a brief
description of the main supervisory actions with regard to MPS, in chronological order:
In January 2008 MPS submitted to the Bank of Italy (BI) its application to acquire ABN AMRO’s
Antonveneta group (BAV) as part of an agreement with Santander. The cost of the operation was
around € 9 billion (€ 6 billion of which was for goodwill). A liquidity commitment – of an
estimated amount of around € 9.5 billion – was foreseen for MPS, for the purpose of repaying
(within 12 months of the conclusion of the contract) the credit lines previously committed by
AMRO to BAV. In line with the applicable legislation, the cost was evaluated in relation to the
capital adequacy and on the basis of its financial sustainability for MPS.
The application contained a plan for a capital increase, which was required in order to remain
compliant with capital ratios. A capital increase of € 6 billion was foreseen, € 5 billion of which was
earmarked for shareholders and € 1 billion for JP Morgan for the issuance of convertible bonds in
MPS shares ,known as “FRESH”; a further € 2 billion was obtained via bond issuance.
In March 2008 the Banca d’Italia informed MPS that the conclusion of the operation was dependent
on the achievement of the above-mentioned capital strengthening measures. With reference to the
capital increase earmarked for JP Morgan and the planned issuance of FRESH bonds, the supervisor
(Banca d’Italia) asked MPS to ensure that the relevant contractual arrangements were consistent
with the core capital status assigned to the instrument and to guarantee the complete transfer of
enterprise risk to third parties.
In May 2008 MPS reported that it had completed its plan to increase its capital, as requested by the
Bank of Italy. On the basis of the documentation provided, the Bank of Italy began an in-depth
analysis of the draft contracts relating to the FRESH operation in order to verify the compliance of
the asset in question with supervisory requirements. Technical discussions with MPS continued
until September 2008, when the BI formally informed MPS of the elements preventing the full

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inclusion in the bank’s core capital of the shares used for FRESH. MPS provided the Banca d’Italia
with new contractual arrangements for the FRESH operation, in line with the provisions of the BI.
In the second half of 2009 the supervisor intensified its close examination of the liquidity conditions
of the MPS group. At the beginning of 2010 the bank was summoned by the supervisor in three
occasions in quick succession in the first months of 2010. In May, the supervisor visited the bank
for a series of informative meetings. It emerged that there was a high incidence of repo operations
backed by long term Italian Government bonds, resulting in the absorption of high liquidity margins
in the context of worsening market conditions. The situation of the bank was considered to be
unclear and potentially critical.
Bank of Italy’s supervisory rules are strict as regards the necessary safeguards for complex financial
activities. The rules, laid down in 2004, state that banks dealing in credit derivatives – as with the
transactions carried out by MPS – must be able to evaluate on a daily basis developments in the
prices of individual products and in the overall risk profile of their portfolios. More generally, the
rules state that banks unable to correctly measure and manage risks associated with complex
financial instruments must abstain from trading in such instruments. In order to gain further
necessary information, a supervisory inspection was launched immediately, looking at the MPS
group’s liquidity management and its financial risk division.
The supervisory inspection was carried out between 11 May and 6 August 2010 and highlighted
tensions in the liquidity situation and a high level of exposure – not measured precisely – to rate
risk. The inspection also highlighted the rigidity of the investment strategies for Government bonds,
the value of which was quite large (around € 25 billion). In particular, the liquidity position,
characterized by high volatility, had been mainly affected by two structured repurchase agreements
relating to government securities carried out with Deutsche Bank and Nomura respectively, with a
total nominal value of around 5 billion euro, with risk profiles that were not adequately monitored
or measured by MPS, nor fully reported to the MPS board.
With reference to the assets of the Santorini vehicle, the inspection did not reveal any information
to support the launch of a sanctions procedure or an alerting of the judicial authorities. In addition to
the significant effect on liquidity, a problem came to light in relation to the accounting criteria (cost
evaluation) adopted by MPS and approved by the auditing company. These procedures gave rise to
reservations on the part of the supervisor as regards the operation’s representation on the balance
sheet, which did not show its fair value. Given that Bank of Italy does not have powers as regards

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accounting, considering the complexity of the operation and the possible room for interpretation
created by the IAS accounting rules, the BI in November 2011 to conduct a more in-depth specific
accounting review of this issue, in collaboration with the other authorities, in part so that an
explanation could be provided to the entire banking system. [Bankitalia relation, 2013]
In the second half of 2010, in part owing to the initial findings of the supervisory inspection, it was
clear that the capital of the bank needed to be strengthened as soon as possible. A formal request for
this was made in late August 2010. In particular, the supervisor requested that the level of increase
initially envisaged by the bank has to be made higher to take into account the exposure to sovereign
risk and the need to strengthen the bank’s reserves in light of the stress tests to be carried out at
European level.
The increase in capital was then to effectively take place between April and July 2011 with a total
increase in core capital of € 3.2 billion, 2 billion of which was to be paid in cash by the
shareholders. In the face of requests for intervention and formal objections, the corporate bodies of
the banks must respond to the findings of the inspection by BI and report to it on the measures
already taken in order to rectify the shortcomings identified by the inspection and measures planned
for the future.
In this context, MPS indicated: the adoption of a new model for the finance division which is
uniform for the entire MPS group; new supervisory and control tasks for the Finance Committee
with regard to the investment choices of entities within the MPS Group, and changes to the risk-
management strategy, with the aim of improving the measurement of financial risk and achieving
more rigorous financial risk management. MPS stated that structured repurchase agreements
relating to Government securities were economically rational in support of carry trade strategies and
the intention to take on reduced risk-return profiles in the context of the overall position of the bank.
For those reasons, and taking into account adherence to operational limits in place, these measures
were not submitted to the board, but approved by the Finance Committee and the Director General.
The supervisor further intensified its scrutiny of the three main areas which emerged as particularly
problematic in the course of the 2010 inspection:
Liquidity risks: the submission to the supervisor of a daily report on liquidity risk was imposed;
strengthened governing procedures and an internal survey on liquidity risks were requested; and a
continuous verification of funding plans with the involvement of management began.

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Interest rate risks: the supervisor requested that a report on risk management has to be sent to it
periodically; the bank was also asked to include its specific interest-rate risk profile in its capital
adequacy assessment;
Sovereign risk: the evolution of the Government securities portfolio became subject to constant
monitoring. Continuous checks on the quality of data revealed organizational and procedural
shortcomings which became the subject of a formal intervention in 2011; but in the absence of
tangible results, the bank was again sent a formal letter of intervention in 2012; the unsatisfactory
response on the part of the bank necessitated the opening of a sanctions procedure in respect of the
former managers.
As of summer 2011 the rapid deterioration in market conditions (the sovereign debt crisis spread to
Italy) caused a further severe weakening of the liquidity position of MPS, on the two above-
especially following the widening of the margins mentioned repo agreements. The supervisor,
through both formal and informal interventions, called for the top management of the bank to focus
on the absolute urgent need to adopt all the necessary measures to re-establish appropriate liquidity
margins. In September 2011, the supervisor launched an urgent second inspection of the bank, in
order to carefully assess the suitability of the measures adopted by MPS. The supervisory inspection
indicated, in the initial phases, that the issues previously highlighted by the BI in its supervisory
capacity had not, in fact, been overcome and confirmed that the MPS group continued to have
significant organizational problems and an inadequate managerial structure. The bank’s liquidity
position became increasingly fragile, indeed in autumn 2011, the BI was obliged to conduct
securities lending operations in order to enable the bank to increase its recourse to refinancing from
the European Central Bank.
Given the difficult situation uncovered as a result of the latest inspection, on November 2011 the
Governing Board of the BI summoned the top management of MPS in order to make them face up
to their responsibilities and ask MPS to quickly and definitively turn around the way it conducts its
business. MPS later terminated the contract of its Director General, Dr Vigni. On January 2012, and
Dr. Viola was appointed as Director General. Upon termination of his contract, Dr Vigni received a
payoff of approximately € 4 million, judged unjustified by BI.
The on-site inspection of MPS was completed on March 2012, after the MPS group’s liquidity
position was normalized, following, among other things, MPS’ participation in the two three-year
refinancing operations conducted by the ECB. The inspection report was highly critical,

14
emphasizing the bank’s serious shortcomings in its liquidity management. A sanctioning procedure
was started on MPS board members, the former Director General, the auditors and the members of
the management committee.
In the inspection report, the structured repo agreements mentioned previously were re-examined.
MPS is criticized for not critically reviewing these operations in terms of their cost and benefits,
even following the findings of the BI on the occasion of the previous inspection. The bank was also
questioned as to data filing irregularities that led to the exposure deriving from these repos being
underestimated.
In April 2012 the majority of the members of the Board of Directors and of the Board of Statutory
Auditors were replaced.
The plan arranged by the new board confirmed the commitment to achieve by June 2012 the capital
target (exceptional 9% of core tier 1 plus a temporary buffer for the holding of state securities) set
by the EBA, aimed at increasing market confidence in the capacity of the banking system to
withstand adverse shocks. Although its capital was well above the amount provided for in the
prevailing regulations, MPS recorded a shortfall of € 3.3 billion. The shortfall was entirely
attributable to the valuation at market prices of Italian Government bonds held in its portfolio
(about € 25 billion); leaving aside the sovereign risk buffer required by the EBA (€ 3.5 billion), the
bank’s core tier 1 ratio as at September 2011 was equal to 9.2%. The plan put in place by MPS to
strengthen its capital did not enable it to make up the shortfall entirely. The BI therefore asked the
Ministry of Economy to adopt a public backstop measure.
On July 2012 MPS provided its response to the inspection findings. In general, having regard to the
entire contents of the inspection findings (weakness of the financial balance, failings in organization
and controls), MPS explained about the Deutsche Bank and Nomura operations, stating that, in
order to reduce the absorption of liquidity by such financial investments, it had tried to mitigate the
collateral obligations by negotiating with the counterparties possible amendments to the relevant
contractual clauses. While some amendments to the contracts were agreed with Deutsche Bank, the
negotiations with Nomura were abandoned by MPS owing to the heavy impact it would have had
on the profit and loss account.
In the light of the above, the BI requested that MPS provide it with an analytical and detailed
reconstruction of the real nature of the transaction as described in the contract provided and an

15
accurate assessment of the current and future impact of the operations. From the end of 2011 the
Banca d’Italia was kept informed by Siena’s Public Prosecutor’s Office about the ongoing
investigation and was in constant contact with the judges dealing with the enquiry.
To conclude, MPS has been subject to detailed supervisory scrutiny, which has made it possible to
identify and put a stop to high-risk activity, leading the bank to strengthen its administrative and
control procedures. Its business is being closely monitored by the BI, in close cooperation with the
new management, which is currently implementing a comprehensive restructuring with a view to
boosting efficiency and restoring adequate profit levels.
4. The responsibilities of Draghi’s Bank of Italy in MPS crash
The Bank of Italy under former Governor Mario Draghi spotted accounting irregularities that
allowed Banca Monte dei Paschi di Siena SpA to mask losses more than two years before the bank
was forced to say it will restate its statements.
Indeed in 2008, in order to finance the acquisition of Antonveneta, MPS incurred into debt and in
the same years the managers of MPS decided to sign with Nomura and Deutsche Bank the purchase
of structured derivatives to cover the lack of liquidity.
At that time the subprime mortgages crisis was already leading to the collapse of the global
financial markets when Mussari, general director of ABI and MPS, announced the acquisition of
Antonveneta to the Bank of Italy, which did not fully exercised its main supervisory function
because didn’t stop this burdensome operation, which clearly lacked of many primary requirements.
Bank of Italy led by Mario Draghi in 2008 knew that Antonveneta was an awful affair, but did not
pass its information to MPS, which overpaid it (around 9 billion). Moreover Mussari decided to buy
without the due diligence, that is without any audit or analysis of Antonveneta statements. Only in
May 2008 the Bank of Italy disclosed its doubts, but it was too late. The permission, which led to
the MPS foreseeable crash, was already granted7
.
Draghi was in charge of Bank of Italy from 2005 to 2011, until he replaced Jean-Claude Trichet at
the ECB. The whole event highlighted the twist of powers inside the Italian banking system, which
in all these years have distorted its identity, becoming more and more tied to politics hampering
bank’s own management.
7
http://www.linkiesta.it/it/article/2013/01/31/la-linea-di-bankitalia-su-MPS-salvate-il-soldato-draghi/11484/

16
Another event showing the relationship between Draghi and the MPS management was the election
in June 2010 of Mussari as president of ABI (with the approval of Bank of Italy and Draghi
himself), and above all his re-election in May 2012: the week after he fell under investigation by the
public’s prosecutor’s office of Siena.
Ultimately the link between Bank of Italy and MPS was enhanced by the issue of “Tremonti Bonds”
and later of the Monti ones. These last are bonds that can be issued by a bank in trouble and
subscripted by the State. They constitute a really opaque hybrid security. They are both a loan with
growing interest starting from 9% up to 15%, and capital for two reasons: they have not a scheduled
maturity and they share the bank’s overall risk in same way as the stocks do.8
Although these securities do not provide the State of any voting right in the bank’s management
decisions and assembly, they are certainly instruments able to generate an amount of interests
impossible to raise elsewhere in the market.
8
http://www.ilsole24ore.com/art/finanza-e-mercati/2013-01-29/peso-montibond-subordinati-
134558.shtml?uuid=AbCUnFPH

17
5. Conclusion: the main consequences for the bank and its managers
Nomura Holdings Inc. will forfeit € 440 million euros to end a derivatives contract and settle
legal claims with Banca Monte dei Paschi di Siena SpA as prosecutors investigate whether the
Alexandria transaction was used to obscure losses at the Italian lender.
The Japanese bank, which was set to earn 799 million euros on the contract, will receive 359
million euros from Monte Paschi to terminate the agreement 19 years early. The accord will
boost Monte Paschi’s common equity Tier 1 ratio under Basel 3 rules by 70 basis points.
Monte Paschi, had to restate its accounts in 2013 to reflect a loss that had allegedly been masked
by the Nomura transaction and a similar deal with another lender. The accord announced solves
in the end legal proceedings that Monte Paschi and Nomura filed against each other in the U.K.
and Italy, the banks said.
The settlement will cut Nomura’s second-quarter results by 34.5 billion yen (€ 250 million), the
Japanese bank said in a separate statement.
Monte Paschi said the settlement will result in a “negative one-off impact” of about 88 million
euros on after-tax earnings this year and will have a positive effect of about € 40 million a year
in the future. It will also increase liquidity by about € 500 million.
“I’m satisfied that we have now closed the last legacy linked with the previous management of
the bank, an important outcome that strengthens the equity of Banca Monte dei Paschi,” Chief
Executive Officer Fabrizio Viola said in the statement.
Nomura “believes that the transactions were conducted legally and appropriately, and does not
accept allegations made against it or admit any wrongdoing in connection with the settlement,”
the firm said in its statement.
Consequently to the agreement, shares of Nomura fell 3.2 percent, the most in four weeks, to
709.7 yen at the close of trading in Tokyo, while the benchmark Topix index declined 2.4
percent.
Mussari was accused of the charge is an obstacle in the competition the duties of public
supervisory authority functions.
Former leaders of the Monte dei Paschi di Siena were convicted obstacle to the Supervisory
Authority for the affair of the structured Alexandria restructuring. For the three defendants,
former president Mussari, the former general manager Vigni and the former head of the finance

18
Baldassarri, the Court found a sentence of 3 years and 6 months imprisonment each with
disqualification from public offices for five years. Prosecutors had asked seven years for
Mussari and six for Vigni and Baldassarri.
The judgment was delivered by the presiding judge Leonardo Grassi at the end of the closed
session, just over three hours and a half. The Court has halved the requests made by prosecutors.
Another encouraging signal arrived few months ago from the market and concerned the price of
subordinated bonds. A usual measure of the degree of risk that the market attaches to these titles
is given by the prices of credit default swaps. CDS are derivatives that works similarly to an
insurance policy. The higher their price the higher is the degree of risk to which you want to
insure. Exactly as the premium of a policy. Typically the price of a CDS grows according to the
years for which we want to insure. In the case of subordinated bonds issued by the Monte dei
Paschi di Siena, however, the opposite happens. The S&P Capital IQ database shows that to
insure yourself one year from the insolvency of these titles you have to pay 22.79% of the
capital invested against 12.05% required for a similar title with a maturity of 10 years. This
signals that the risk on these securities, although high, is not perceived as imminent. The degree
of riskiness of subordinated bonds MPS is similar to that of Greek government bonds. The
reason for this is clear: with the entry into force earlier this year of legislation on bank bailouts
(namely "bail-in"), creditors are more likely to lose on their investment if the issuer were to be
subject to "bail-in." A procedure which requires that the ones who take charge of the bank
rescue in difficulty are the shareholders and the creditors according to their degree of privilege.
Nowadays, the last results of the Sienese bank provide hope for stabilisation of the situation,
although it may not be totally considered out of the chance of default. On 31st
of March 2016,
the MPS Board approved the following results: a net profit of 93 millions, supported by the
decrease in loan loss provisions; a solid capital position, with transitional Common Equity Tier
1 at 11.7%; a decrease in net non-performing loans (-0.4% Q/Q) and an increase of coverage to
49% (+59 bps). Further improvements came out in asset quality: loan loss provisions fell down
of 40% compared to the fourth quarter of 2015 and they are at the lowest level in the past four
years. In addition on 20th
of April 2016, MPS declared that Fitch rating agency has confirmed
the Issuer’s ratings with a stable outlook.

19
Appendix
 Alexandria Original Structure
 Alexandria Renovation Structure

20
References
 http://www.bloomberg.com/news/articles/2013-01-17/deutsche-bank-derivative-helped-
monte-paschi-mask-losses
 http://www.bloomberg.com/news/articles/2016-02-16/milan-prosecutor-said-to-seek-
charges-against-bankers-for-paschi
 http://www.bloomberg.com/news/articles/2015-11-06/monte-paschi-posts-third-quarter-
loss-on-alexandria-settlement
 http://www.borsaitaliana.it/notizie/sotto-la-lente/assetbackedsecurities.en.htm
 http://www.ilsole24ore.com/art/SoleOnLine4/100-parole/Economia/R/Reference-
entity.shtml?uuid=9819859e-5807-11dd-93cb-a54c5cfcd900&DocRulesView=Libero
 http://www.ilsole24ore.com/art/finanza-e-mercati/2015-09-24/montepaschi-fa-pace-nomura-
065943.shtml?uuid=ACePNi3&refresh_ce=1
 http://www.ilsole24ore.com/art/finanza-e-mercati/2016-01-20/per-mercato-derivati-titoli-
subordinati-mps-sono-rischiosi-come-bond-greci-
145515.shtml?uuid=ACiZWnDC&fromSearch
 https://www.bancaditalia.it/media/approfondimenti/2013/interventi-gruppo-
MPS/Interventi_MPS3.pdf
 Sentenza di primo grado n° 762/2014, 30.10.2014, Tribunale di Siena
 BMPS Consolidated Balance Sheets https://www.MPS.it/investors/investor-
relations/Pagine/index.aspx
 Roberto Baviera, 2013, MPS Affaire: Prodotti Strutturati e Derivati, QfinLab Politecnico
di Milano
 Vincenzo Cantarella & others, 2010, Ispezione ai sensi delle disposizioni in materia
bancaria e finanziaria, Bankitalia
 F. Viola & B. Mingrone, 02.07.2013, MPS Analysts & Press Presentation, Siena

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