Italy is increasingly at odds with the EU over economic and immigration policies. Will we perhaps see an IEXIT anytime soon?
In recent months, particularly after the BREXIT vote, Italy has come under sharp focus as one of the so-called PIGS (Portugal, Italy, Greece and Spain) nations as the economy continues to struggle, none more so than in its banking sector. Approximately 18% of bank loan are now determined as non-performing (see graph below), which is 10 times the level we currently see in the US and over 3 times what it was at the height of the financial crisis in 2008. Furthermore, Italian banks now account for almost half of the total bad loans amongst publicly traded banks in the entire eurozone.
Bank non-performing loans to total gross loans (%)
The impairments at Banca Monte dei Paschi di Siena were so acute that they assigned a team of hundreds of people to create a purpose-built function to handle them in the hope of selling these bad loans to a foreign investor to speed up the liquidation process.
Sluggish Italian economic growth, forecast to be below 1% this year, coupled with low and even negative interest rates is seen as aggravating confidence in the Italian banking sector. Despite the fact that Italy only has one bank, Unicredit, classified as globally significant under international banking regulations, stresses throughout the Italian banking sector could lead to systemic problems developing. Italian bank profitability has been affected by overstaffing, too many branches and a reliance on traditional lending, exacerbated by ongoing low-interest rates, with less reliance on asset management and investment banking.
In 2014 the EU introduced an “anti-bailout rule”, which forced troubled banks’ stakeholders, shareholders, bondholders and potentially depositors to bail-in a bank before the nation’s taxpayers. Italian banks’ ongoing problems have seen their government seek EU permission to inject €40 billion into its bank system. Rome argued that this was a small price to pay to prevent contagion problems spreading throughout the Eurozone. However, Berlin rejected this idea out of hand.
Rome has criticised these “bail-in” rules because they would be particularly harmful to them, not least in that €187 billion of bank bonds are in the hands of retail investors whose holdings would be wiped out by such a ruling. Tougher rules relating to declaring loans as being impaired now exist and as a consequence impaired loans at Italian banks now exceed €360 billion, four times that seen in 2008 and unsurprisingly, they continue to rise. The discrepancy in valuations of bad loans, as low as 20% of their true value, suggests an additional €40 billion in write-downs.
Clearly, further slowdown in economic growth is likely to see more loans become impaired, impacting bank profitability and capital requirements to stabilise banks. Some analysts are predicting Italy’s growth to be 0.8% this year and 0.6% next year. Another concern is capital outflow associated with share price performance, which saw depositors removing their money out of Banca Monte dei Paschi after its share price fell by more than one-quarter in a matter of days this summer.
Bolstering capital is also an issue. UniCredit SpA, which is Italy’s largest bank in terms of assets, has already undertaken €74 billion in loan write-downs and capital increases since 2008. With €80 billion in non-performing loans and failing profitability, its capitalisation barely meets ECB requirements. It is believed that any future restructuring plan will require as much as €9 billion to stabilise the bank.
Only this week Italy’s third largest bank, Monte dei Paschi, which failed the latest ECB stress tests has assured markets that it would raise €5 billion via a private sector bailout. Speculation in the Italian media has suggested that this fund-raising is not going well and has come about because Berlin will not permit a public sector bailout, according to 2014 legislation passed by the EU which demands that “bail-ins” are required.
Monte dei Paschi threatens to further erode confidence in the Italian banking sector and impact Italy’s heavily indebted economy, with public debt as a percentage of GDP currently standing at 133%, second only to Greece at 176%. Its budget deficit is currently running at €40 billion per annum, or 2.4% of GDP and expenditure on interest payments as a % of GDP is 4.18%, the second highest in Europe behind Portugal 4.57%, with an average of 2.29% amongst all 28 EU nations.
The following graphs illustrate in part the deepening economic crisis which is engulfing Italy.
GDP per Capita
Production of Total Industry
Consumer Price Index
Unemployment (All Persons)
Unemployment (15 – 24 Years)
The rift between the EU and Italy continues to grow over a lack of commitment on the economy and immigration at the EU’s recent conference in Bratislava. Italian Prime Minister Renzi has already issued the EU with an ultimatum over the migrant crisis, telling Brussels to deal with it or his government will. European Commission President Juncker said Italy had already been able to spend €19 billion because of the stability pact but warned that there would not be any further extension of this arrangement creating further tension between Italy and the EU.
Italy appears to now be at a crossroads. It is in a head on collision with the EU over its own finances, immigration and its banking sectors. Italy knows that any attempts at bail-ins would lead to outright revolt amongst its people and would undoubtedly trigger a wider crisis in confidence in its banking system. Italians will head to the polls to vote in a referendum on a constitutional reform that Renzi says will make it easier to pass legislation by dramatically restricting the powers of the senate, a major source of political gridlock. The referendum could take place on November 27 or on December 4, Renzi recently told Italian television. He is clearly gambling his political future as much as David Cameron did over BREXIT but in a broader context, Italy needs to address the primary concern, namely should it actually leave the EU?