Bank of Italy says crisis tools for small banks needed

By Andrea Mandala and Valentina Za

MILAN (Reuters) - The Bank of Italy on Saturday called for European rules to handle smaller banks' crises and urged them to consider mergers to cut excessively high costs.

Speaking at the annual Assiom-Forex conference of financial markets' participants, Bank of Italy Governor Ignazio Visco said European banking rules introduced after the global financial crisis made it harder to find solutions when a small lender ran into trouble.

Italy's fragmented banking system has been hit by a string of small bank failures in the wake of a deep recession. The government and healthy banks have been forced to step in, shouldering significant costs, and the central bank's supervisory activity has been called into question.

"Nowadays the traditional banking model offers low returns ... small and medium-sized banks are the most affected and struggle to strengthen their balance sheets owing to high costs and difficulties in gaining access to the capital market," Visco said.

Banks' thin profit margins make it difficult to find investors ready to provide fresh capital to a troubled lender, especially when it operates in unattractive areas.

Under current European rules, "the only way forward in the event of a crisis is a piecemeal liquidation, resulting in a loss of value and in contagion risks."

Visco defended the Bank of Italy's actions in relation to Popolare di Bari, the biggest lender in the country's underdeveloped south and the latest bank to be rescued by the state and other rivals, at the end of last year.

"Supervision is intensive, including on the smaller banks," he said. Accusations the Bank of Italy had turned a blind eye on Popolare di Bari's weakness and allowed it to take over rival Tercas were "unfounded and highly offensive", he added.

Visco said mergers could help smaller banks build much-needed scale. Costs at smaller peers with a traditional business model run on average at 72% of their income, compared with 66% at bigger rivals, he said.

"The process of restructuring must proceed with determination ... initiatives to expand the scale of operations of small banks such as mergers or greater integration of business areas ... can prove beneficial," he said.

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Crisis tools for all types of banks as well a single deposit insurance scheme across the euro zone are necessary steps toward the bloc's integration , Visco said, calling also for the introduction of a common risk-free debt instrument.