Article / 06 July 2016 at 13:00 GMT

Bigger than Brexit? Italian banks threaten the EU

Managing Partner / Spotlight Group
United Kingdom
  • Brexit vote, inconclusive Spanish election, Italian banks crisis weigh on EU
  • Italian PM Renzi calls for referendum on reforms; populists gain in local votes
  • Southern Europe's economic woes are a significant threat to the Eurozone

Rome's Piazza Navona
London may appear to be at the centre of the EU's current bout of existential woe, but Italy 
and the South in general could prove a larger problem than Brexit. Photo: iStock 

By Stephen Pope

Europe is on troubled ground as the summer of 2016 unfolds. On June 23, the UK voted in a referendum to leave the European Union. This was quickly followed on June 25 by the second general election in Spain within six months, a ballot that once again proved inconclusive.

All eyes on Italy

Italian prime minister Matteo Renzi has called for a national referendum on an overhaul of the political system. The question is centred on reducing the number of senators to 100 from 315 and to impose a limit the upper chamber’s power to bring down governments. 

This is aimed at bringing the ongoing period of unstable government to an end.

An opinion poll consisting of over 1,000 interviews held by Euromedia Research on July 1 found that if the vote was held now, 34% of Italians would vote against Renzi’s plan, with just 28.9% in favour. 

The outcome, however, remains an open question as 19.4% of the electorate are undecided on which way to vote and a shocking 17.7% are actually undecided on whether to vote at all.

Renzi has promised to quit if he loses the referendum. Such a course of action would be seen as a terrible blow to the overall European economy, which is already fragile. If Italy refuses to reform, it will lead to another political vacuum and a period of uncertainty with no credible champion to lead the moderate centre.

Recent local elections showed that the populist parties are increasing their appeal, suggesting that a working government with a majority will be hard to achieve. If Renzi’s reforms are rebuffed, it is the anti-establishment Movimento 5 Stelle (Five Star Movement, or M5S) that is poised to make the most gains.

An opinion poll by the Demos institute last week showed that M5S had overtaken Renzi’s Democratic Party to become the country’s most popular political group. What will set alarm bells ringing in Brussels, Berlin, and Paris is that M5S wants to hold a referendum on Italian membership in the euro.

If the referendum delivers a result that offers any encouragement to the anti-establishment parties, it will lead to renewed difficulties for both the Eurozone and the union as a whole.

Italian PM Matteo Renzi
Renzi greets a crowd in Torino; the Italian leader's proposed reforms could represent 
a "sink-or-swim" moment for the troubled country. Photo: iStock 

Frangible finances

Italy's near-term economic prospects are not encouraging as the International Monetary Fund has forecast that GDP will expand only 1.1% this year, lagging behind most other Eurozone economies. Italian unemployment in May was stuck at 11.5%, exceeding the 10.1% average for the 19-nation region. 

More worryingly, youth unemployment stands at 36.9% versus 20.0% during the financial crisis.

The business lobby Confindustria forecast on July 1 that Italy’s economy would fall back into recession in case of a “No’’ vote on the Senate reforms as domestic and foreign direct investment would decline 17% over three years.

There is a danger that reporting on Europe can become somewhat hysterical and so let it be stated that even if the reforms are rejected, it would imply that even if Italy is eurosceptic, it is not about to leave the EU. 

(Even if the Northern League have deep reservations...)

The vote is not expected until October, but as we have seen in the case of the UK decision, nature and investors abhor a vacuum and the markets are showing their concern.

Soaring spreads

Italian government debt has started to underperform relative to Spain. The yield on 10-year Italian BTP, 1.60% June 2016 debt rose to 1.251% on July 5 a spread of 5.9 basis points over the Spanish 10-year BONOS, 1.95% April 2016.

One month ago, the spread had Spain's yield higher than Italy's by 10.9 bps. In one month the Italian paper has underperformed Spain by 16.8 bps.

Broke bank mountain

The biggest threat to the Italian economy – more threatening than the referendum on political reform – is the troubled state of the banking system.

Italian banks are overloaded with bad debts. Non-performing loans have risen from 5.9% of the total outstanding in 2007 to 17%. Banks in Italy are carrying approximately €360 billion in nonperforming loans according to the Banca d’Italia. Of this total, 58.3% or €210bn of those loans have now been classified as insolvent.
Italy NPL

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Source: Bloomberg, Business Insider

This has to be put in context: in the US banking system at the height of the financial crisis, just 5% of the total of outstanding bank loans were classified as “bad”.

Italy's banking system has traditionally focused on "plain-vanilla" lending such as holding deposits and lending to businesses and homeowners rather than lucrative and more complicated investment banking, trading, or asset management.

While that may sound secure, such an approach has left the banking system exposed to the zero or even negative interest rate policy of the European Central Bank given that the simpler and safer banking activities are closely linked to benchmark interest rates set by policymakers.

Markets, however, have taken note of the problems within the banking system and have driven shares of several prominent banking firms lower. Banca Monte dei Paschi di Siena SpA stock has fallen to an all-time low. The price fell by 14.0% on Monday this week and by another 19.4% on Tuesday. There has been a small recovery in early Wednesday trading, but this bank is far from out of the woods.

BMPS shares are off 76% for 2016 and are not alone in the debacle. UniCredit SpA is Italy’s largest bank by assets and is lower by 63% this year, while Banca Popolare di Milano SpA is down about 64%, and Intesa Sanpaolo SpA (ISP) has shed 46%.

In April it was suggested that the central government could step in to offer support to the banking system; the speculation held that Rome was considering a cash injection of up to €3bn into BMPS. If I tell you that this would be the bank's third bailout since the financial crisis, however, one can start to appreciate the scale of the problem.

Italy... increasingly exigent

Matteo Renzi has a tough task ahead. He urgently needs to fix the political and banking systems and somehow overcome the sense that commercial activity in Italy is tainted. Transparency International ranks Italy as 61st among 168 nations on its Corruption Perception Index. 

Similarly, reform has to cut red tape as the “Ease of Doing Business” in Italy deteriorated to 45 in 2015 from 44 in 2014 (versus 74 before the financial crisis).

As I see Europe right now, its southern flank is looking vulnerable. After six years, Greece is no closer to extracting itself from its debt and economic crisis. After two elections in six months, Spain is still only governed on a supply and confidence basis, and Italy is critically short of runway as it tries to reform and get its economy airborne. 

The EU may have lost one member on June 23, but it is in serious danger of being undermined by it sad and sorry southern states as well.

Searching for photos of Southern Europe's beautiful capitals is unfortunately
far more rewarding that searching for jobs in them. Photo: iStock 

Edited by Michael McKenna

Stephen Pope is managing partner at Spotlight Ideas


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