Europe’s banks stress test highlighted a crisis in the Italian banking system, in particular Banca

Monte dei Paschi di Siena (MPS). Prior to the tests, MPS saw its shares drop more than 30% in two days after the European Central Bank (ECB) ordered the lender to cut billions in bad loans and prompted Italian market regulator Consob to suspend selling as the stock plunged. The oldest bank in the country and in the world reacted to the poor result of the stress tests with the announcement of a €5 bn capital increase to avoid a bailout.

Brexit erupted in the middle of an existing crisis, worsening the scenario and further denting investor confidence in the banking system and more broadly in the country. Investors are wary about the solidity and lack of liquidity in the Italian banking system due to the heavy burden of non performing loans (NPLs), which amount to over €360bn.

According to analysts at Bank of America Merrill Lynch in London, “a system wide solution for Italian banks is unlikely to be secured by the Italian government in the short term”. They instead predict a move to ensure“adhoc cushions for specific banks” to limit market pressure while negotiations for a more comprehensive plan are likely to continue for months.

MPS is not the only bank in trouble, the entire country and even the continent’s banking system is facing the risk of a collapse. To better understand what’s at stake, where the problem originated and possible future implications, IFM spoke to Carlo Milani, Research Economist at Polytechnic University of Milan and CEO of BEM Research.

Carlo Milani,

Carlo Milani

Could Italy’s banking problems mushroom into a broader European crisis?

Yes. Italy’s banking crisis could have consequences for the whole Europe due to both risks of contagion and of sustainability of Italy’s public debt.The problem is indeed twofold. There are concerns regarding the resources needed to rescue the troubled banks, and the likely new recession that would derive from it.

Is MPS the only ‘sickest ‘patient’ or are other Italian and European lenders also on the verge of getting hit hard by the ‘Brexit epidemic’?

Among other troubled banks in Italy, both Carige and Unicredit are on the radar due to problems related to low capitalisation and profitability. In Europe, the other big ‘sick patient’ is Deutsche Bank, while other Landesbanken are also involved. On the other hand, Greek banks obviously are not immune from this difficult scenario.

Non performing loans are an endemic problem of Italy’s banking system.When did it start and why hasn’t it been addressed earlier?

Nonperforming loans were born out of the mismanagement of credit since the start of the euro.Low interest rates prompted loose loans, especially to businesses, leading to the bubble that burst amid the crisis. The problem wasn’t acknowledged and recognised earlier because, during a period of increased pressure on Italy’s public debt, it would have highlighted the pitfalls and induced to admit that the financial system was not solid. The potential consequences would have been huge, taking the country under the Troika’s control as in the case of Greece, Ireland and Portugal. The government officials hoped that the situation would improve, but due to the second recession triggered by credit crunch, it worsened.

 

The Italian government is negotiating a deal with the EU for a more flexible application of state aid rules to inject €40bn into banks. Is getting the green light from Brussels a viable solution for the long term or is a strong bad bank needed as the last resort?

Yes, state intervention is necessary at this point. Postponing the creation of a bad bank for years has made the problem even bigger to the extent of becoming a systemic issue for the country. Strengthening the bad bank (Atlante) and recapitalising many of the largest lenders is the only way forward.