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Banks, Financial

RBS emerges as biggest failure in tough UK bank stress tests

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Categorized | Banks

Italy’s banking system needs intensive care

Posted on November 24, 2016

When a crisis has passed, the survivors should be wiser for it. How much Europe learnt from the global financial crisis may be tested soon, in Italy, where the banks are in a perilous state.

Italy and the EU will have to work together to prevent a systemic shock. As a first step, the EU should not insist on a rigid interpretation of its bank bail-in rules — allowing Italy the space it needs to prevent bank collapses and limit the risk of financial and political contagion.

The likelihood that further government intervention will be required is high. Yes, UniCredit, the country’s largest bank, is seeking to raise €13bn capital, and Monte dei Paschi, its most troubled large bank, may close a €5bn combined debt-for-equity swap and capital increase this week. But these sums are small compared with the system’s needs and the worst problems are concentrated in the smaller banks.

The woes of the banks stem from the Italian economy, which never recovered from the most recent crisis. Gross domestic product per head is 9 per cent smaller in real terms than it was in 2007 and is stuck near the levels of two decades ago. Italy staggers under an ageing population and the second highest public debt load in Europe, at more than 130 per cent of GDP.

Italy’s financial system is based on mutual and co-operative banks which have traditionally put their role in supporting local economies above profitmaking. The country is wildly overbanked, with more branches per capital than any other OECD country. This structure, and the lack of growth, has suppressed profits at all banks and caused non-performing loans to metastasise. There are €360bn of impaired loans in the system, according to the Bank of Italy; €200bn of these are of the worst sort, the non-performing sofferenze. This is a huge number given that there is €225bn in equity on the books of the banking system. And this may understate the rot. Banks close to being bust have reason to mark the value of their assets generously.

There have been efforts at reform and repair. Some mutual banks have merged. Atlante, a €4.25bn government-funded investment fund, has absorbed bad debts. But much more consolidation is needed, and it should be followed by brutal branch-closing and cost-cutting. Atlante has expended nearly all of its buying power already.

If the government were to inject capital into the banking system, EU rules would require — at the very least — that subordinated creditors be converted to shareholders. This would be politically explosive.

Italian banks have long sold their own shares and debt to their retail customers as an attractive alternative to savings products, a disgraceful practice that should never have been allowed. It means that ordinary Italians, many in retirement, have already suffered as bank shares have fallen. They will suffer much more in a bail-in.

The referendum on Matteo Renzi’s constitutional reform will take place on December 4. If the result is no, the country will enter a period of uncertainty. Combining political risk with bank collapses could have serious repercussions for all of Europe.

The bail-in of subordinated debt holders could be made palatable if a robust indemnification regime were put in place to protect retail holders up to a certain level. The EU should make sure Italy is free to fund such a scheme.

The situation in Italy will remain fluid and dangerous. This may not be the last time the EU will have to show flexibility. In return, Italy needs to make a firm commitment to a rigorous process of triage through which banks are forced to merge, close or shrink.