Italy is in the thick of a banking crisis, which some describe as a greater risk than Brexit and which could threaten the Eurozone. The crisis claimed a prime minister, who quit following a referendum to amend the country’s constitution to give the government more power, and the confusion that came in its wake left the banking sector face the dire prospect of bankruptcy. One of the banks that is facing virtual closure is Banca Monte dei Paaschi di Siena, or BMPS, which it the oldest surviving bank in the world and the third largest in Italy. The impact this will have on the country’s banking system is huge to the extent that other major banks may collapse and the Eurozone itself could vanish.
BMPS, founded in Siena in 1472, has been in trouble for years. Its resources were hit by the purchase in 2007 of Antonveneta Bank at twice the estimated value. There were accusations of fraud and misuse of funds against its management. It subsequently ran up huge losses and in 2015 it posted a profit for the first time in five years. But there has been no solution to its non-performing loans (NPLs), estimated at 45 billion euros. The bank tried to sell 27.6 billion euros of doubtful assets and raise up to five billion euros in capital to strengthen reserves. The first step of that plan – the voluntary conversion of bonds into shares – has allowed it to book the first billion of needed capital.
POLITICAL INSTABILITY
The bank has decided to pursue this strategy even as political instability has grown in Italy after the resignation of
Matteo Renzi’s government. The bank wants to open the possibility of converting debt into equity to retail bond holders who were excluded from the first round of conversions.
Italians and people in the whole of what is left as Eurozone are optimistic that BMPS and other crisis ridden banks would ultimately be rescued. Banks have to be rescued as otherwise the economy could go down the drain. Italy and its new government will have to devise a new strategy – perhaps funding from the government to prop up the collapsing banks. But there is a rider. According to EU rules governing banking, which came into being in January 2016, when a bank faces existential problems, its existing stakeholders – shareholders, creditors and depositors with deposits in excess of the guaranteed amount of €100,000 – should absorb part of the losses before the government can step in. Italy has a peculiar situation. The subordinated bonds that are expected to take a hit in the wake of the banking crisis are owned mostly by small savers who have been fooled into buying them by the mis-selling deeds of the banks. These bonds are estimated to be worth around €60 billion. When the government decided to act in this regard, the results were obvious. There were even suicides by the bond holders, who in their suicide notes revealed that the banks concerned had fooled them into buying what were described as risk-free bonds.
IMPACT ON EU
Then, there are French, and German, Spanish and even US, UK and Japanese banks which have exposures to the Italian government’s total debt – which is estimated to be in excess of €250 billion. Germany holds €83.2 billion worth of Italian bonds. Deutsche Bank alone has nearly €12 billion worth of Italian bonds on its books.
Naturally, governments of these countries would not therefore want the Italian banks to fail That is why there are efforts in the IMF and ECB to design a rescue mission for the Italian banks.
There are economists who suggest a way-out for the Italian government. There are suggestions like the central bank should buy the NPLs of the distressed banks with quantitative easing, or QE, and the government borrowing from the banks rather than from bondholders. It is pointed out that borrowing in the bond market fattens the underwriters but creates no new money in the form of bank credit for the economy, but borrowing from banks does create new money as bank credit.
RISING NPL
Having said all these, the Italian banking crisis centers around the fate of BMPS. In 2016, the bank tried to take care of 28 billion euros in NPLs, which account for 36% of the bank’s loan portfolio. That is the highest proportion of NPLs of any bank in Italy. When this distressed situation became known in public, investors and depositors began withdrawing their money, leading to a virtual liquidity crisis. At one point of time, the bank had just 11 billion euros in liquidity. The bank could not solve the problem as private sector and other financial institutions failed to respond to its pleas for help. It then approached the Italian government towards the end of December and the Italian cabinet announced that the bank would be rescued with a 20-billion-euro fund approved by Parliament. While fund infusion from this would help the bank to meet its most immediate needs, there is no solution to its long-term needs. There are estimates that the bank would
need at least 38 billion euros for recapitalization purposes.
It is estimated that nearly one-fifth of all loans in the Italian banking system are classified as troubled, which is worth around €360 billion, at the end of 2016. This represents roughly 40% of all the bad loans within the Eurozone.
Italy has been gradually moving into a financial crisis. Economists cite cronyism, poor lending standards and a double-dip recession have all contributed to creating the €350 billion bad loans, turning many institutions into virtual standstill. Successive governments have failed to reckon the scenario, mainly because European bank-resolution rules would require them to impose losses on creditors, including mom-and-pop investors who bought bank debt without recognizing the risks.
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