The Italian banking sector has been under significant pressure since Brexit. In the months after the UK voted to leave the EU, the Italian bank index dropped by some 26%, and even though it eventually recovered part of the losses, it remains close to its 2012 record-lows. A high volume of bad debts (worth some €360 billion), high operating costs, and low profitability due to current record-low interest rates are the main factors undermining the sector.
In order to tackle bad loans, the government passed legislation that includes measures to streamline the procedure to recover nonperforming loans (NPLs). It also accelerates the tax deductibility of loan losses, allowing banks to claim tax relief over losses due to loan write-downs in one year rather than in five. According to the central bank’s estimates, this could reduce the average duration of NPLs from four to three years, as well as help increase the market price of distressed credits, thereby making it easier for banks to sell their bad debts to specialized investment groups.
Despite the government’s intentions, these measures have so far proved ineffective in reviving hitherto scarce bank lending and restoring financial markets’ confidence. Financial institutions seem to continue to address the need to work through their bad debts by curtailing lending. Data from the Bank of Italy reveal credit to the nonfinancial private sector fell by 1.7% year over year in November, following a 0.5% contraction the previous month.
Although downside pressures have increased further following rejection of a constitutional referendum by Italian voters in early December, the overall banking system is, D&B believes, solid and has demonstrated a good capacity of resilience. Against this background of a sound financial environment, however, a few specific vulnerabilities (caused by a prolonged economic drawdown) need to be addressed in order to restore banks’ financial health, as well as their capacity to promote economic growth.
Unicredit, the only Italian financial institution regarded as critical to the stability of the global financial system, has disclosed plans to raise some €13 billion to straighten its balance sheet and tackle the high volume of bad debt that currently curtails its profits. If successfully implemented, the recently unveiled measures (which envisage deep job cuts, among other things) should bring the banks’ core capital ratio above 12.5% by 2019.
Meanwhile, Monte dei Paschi di Siena (MPS) continues to top D&B’s watch list. In December the bank (saddled with nonperforming loans) failed to raise €5 billion to address its capital shortfalls through a private-sector-led recapitalization: Private investors opted out of the investment due to the ongoing climate of political uncertainty.
In order to avoid possible bank runs, the Italian government offered a bailout worth €6.5 billion, after the cost of saving rose to almost €8.8 billion due to a rapid deterioration in the bank’s liquidity over the past month. At the same time, subordinated bonds held by the bank’s institutional investors will be converted to shares in order to raise an additional €2.3 billion.
On a more positive note, the political crisis triggered by the resignation of former Prime Minister Matteo Renzi following the rejection of proposed constitutional reforms in early December appears to be subsiding. Paolo Gentiloni (head of a Democratic Party-led caretaker government) was sworn in as interim prime minister, two weeks after Renzi lost the referendum.
Fostering economic growth in the south of Italy and tackling the high level of youth unemployment will be focal points of the new government’s policy agenda. Despite resolving the political crisis in record time, the country faces continued uncertainty in the political arena, a major source of concern in the months ahead. The prospect of snap elections continues to loom, and the ensuing political instability could further negatively impact Italy’s outlook.
Daniele Fraietta has been a D&B economist for more than two years. He currently covers some Western European countries, notably Italy, Greece, Spain and Ireland. For D&B, Daniele has also developed the new econometric framework for commodity prices and exchange rates forecasting. He has an MSc in Economics from the University of Rome Tor Vergata, a Master in Business Administration from The Polytechnic University of Milan, and a Master in International Business from the Chapman College of Business.