- Bad debt is rearing its head again for Italian banks
- New government fund struggling to pay the bills for the ailing sector
- Subordinated bank debt has been sold to ordinary Italian investors for years
Friday's bank stress tests will be closely watched in Rome, as retail Italian investors are exposed to the banking sector's bad debt. Photo: iStock
By Michael Boye
While the Eurozone debt crisis – which, at its heights, threatened the membership of several countries in the single currency – is firmly in the rearview mirror for most investors, one of the unresolved problem, which has remained latent for years, is the extensive bad debt in the Italian banking sector.
This issue has been pushed back to the surface by the new non-performing loan regulations, enforced by the European Banking Authority earlier this year. The Italian banking system is estimated to have around €400 billion in total non-performing loans for which it now has to put up far more capital, thus endangering the solvency of several banks.
In response, the Italian government earlier this year launched a fund, dubbed Atlante, with the purpose of funding and buying bad debt off banks' balance sheets, but at just €5bn, it has struggled to pay the bills for the ailing banking sector so far.
However, this is in conflict with the new banking union and its bail-in regime. Under these rules, put in place to combat the obvious moral hazard concerns with government involvement, European sovereigns are prohibited from injecting capital into private banks, without "bailing in" private investors first. This was exemplified by Banco de Espirito Santo in 2014, where equity and subordinated debt investors were left fully absorbing the loss, while senior investors and depositors stayed clear of settling the estate. It would seem a hard sell to argue that Italy should deserve an exemption this time around.
The issue is having implications far beyond Italy's borders as well, as investors all over Europe are closely watching the outcome. Is the European Union going to play hardball and stand by its rules, or is this going to be another case of strict peacetime regulation being modified according to political convience in wartime?
Source: Bloomberg Finance
The answer will especially impact the pricing of subordinated bank debt across Europe, where investors still struggle to find out who is too big to fail - and who isn't. So far, subordinated financials have been among the worst-performing sectors in European credit this year - credit spreads of the latter are still wider for the year, while most other sectors have tightened.
This could quickly reverse, though, if investors are given another assurance of public back-stop once again.
— Edited by D. Deacon