Matteo Renzi’s government faces many serious challenges. It is contending with sluggish economic growth and a European migrant crisis, while waging running battles with Brussels over its public finances. Mr Renzi is even fighting a potentially existential referendum over reforms to Italy’s political system. Yet the issue that may derail the centre left leader is the uncertainty engulfing his country’s banks.
After years of Italian governments dodging the problem, Mr Renzi is at least trying to confront it. He has already had one go this year, obliging a group of largely private institutions to inject €5bn into an optimistically named fund called “Atlas”, whose purpose is to recapitalise some of Italy’s ailing banks. This week, alarmed at the shockwaves rippling through the markets after the UK’s Brexit vote, Mr Renzi decided that this popgun was inadequate and rummaged for something more in the line of a bazooka. This would have involved him persuading his eurozone partners to allow Italy to inject €40bn into the sector in the form of direct state aid.
Mindful of new EU rules on bank resolution, the European authorities have rebuffed Mr Renzi’s entreaties. But even had they not, it is hard to see even his larger scheme being enough to set the banks back on their feet.
On Thursday, the Atlas fund announced that it would take control of Veneto Banca after an €1bn capital increase demanded by EU bank regulators attracted zero interest. That means the fund has already devoured more than half of its capital simply rescuing two midsized regional banks.
The snag is that this barely scratches the surface. There are still €200bn of bad loans on Italian bank balance sheets — of which €85bn remains unprovided for. These numbers may grow if Italy’s still fragile economy is forced back into reverse by the shock of Brexit. Already they dwarf even the larger rescue plan for which Mr Renzi has been pushing. Analysts have estimated that the gap may amount to some €100bn.
Mr Renzi’s concern is that cleaning up the banks while living within EU rules could provoke a political earthquake. To do so would require him to bail in bank bondholders whose ranks may include many retail investors. An attempt to do just this with four failing regional banks last year provoked a political outcry. It doesn’t help the premier that many of Italy’s weakest regional banks happen to be in areas dominated by the centre left.
But Mr Renzi has neither the luxury of options nor of procrastination. The European Central Bank is poised to publish the results of its latest stress tests next month. These may result in further capital demands Italian banks are ill-placed to meet.
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Mr Renzi’s concerns regarding retail investors are understandable. But he cannot allow these to hold up the strengthening of the financial sector nor the urgently needed consolidation of Italy’s myriad small regional banks. Forcing solvent institutions to bail out weaker ones by expanding the Atlas fund will not strengthen the whole system. Instead he should grit his teeth and go ahead with what resolutions are needed, while taking steps to protect the vulnerable. This could be achieved by compensating retail holders for any bail-in related losses on their bonds up to a certain monetary value.
There are no easy options for Mr Renzi. He must somehow balance the needs of the financial system without trashing his party’s own popularity ahead of a crucial referendum. Italy’s EU partners should show some understanding. The consequences of continued inaction could be ugly indeed.