Alaco

04.08.2016 | Italian banking crisis deepens

A post-Brexit fall in shares and anxiety over EU stress test results have compounded the problems faced by the country’s troubled banks.

In recent weeks, Brexit has dominated European headlines.  But there is another potential crisis looming on the horizon for the EU that has been largely ignored until now.  Attention has finally turned to Italy’s banking turmoil, following the announcement on Friday that – as expected – Banca Monte dei Paschi di Siena performed worst of all 51 banks subjected to the European Banking Authority’s stress test.  The world’s oldest bank is officially Europe’s weakest.  Again.

Banca MPS has struggled since the global financial crisis, but the roots of its problems extend further back.  In the 1990s and 2000s MPS embarked on a costly expansion policy, leaving it financially overstretched.  The bank nearly collapsed and has had to ask its shareholders and the Italian government for capital injections several times since the crash.  In 2013 MPS’s former Chairman, CEO and CFO were imprisoned for orchestrating a scheme to hide over €700 million in losses linked to derivatives trades.

The good news is that late last week reports emerged of a private rescue deal for MPS, finally reversing the downward trajectory of its share price.  The bad news is that MPS is far from being Italy’s only troubled bank.  Despite the country emerging from recession in 2015, Italian banks have been buckling under the weight of €360 billion in non-performing loans – the legacy of the global financial crisis that saw the Italian economy stall and property prices plummet.  To make matters worse, Italian banking shares tumbled a further 30% after Brexit.  The stress tests highlighted the sector’s weaknesses and even Italy’s leading lender UniCredit was ranked in the bottom five of the 51 banks tested.  Trading in UniCredit shares was temporarily suspended on Monday as investors rushed to offload them, causing an 8% drop.

For now, Banca MPS’s €5 billion recapitalisation plan has bought Prime Minister Matteo Renzi some time.  He has been in discussions with key EU institutions for months over new banking rules, which state that in the event of public bank requiring a bailout, bondholders would be required to pay out first.  This is designed to stop taxpayers shouldering the burden, but the problem for Italy is that a third of bank bonds are held by ordinary Italians, rather than institutional investors.  This could spell personal bankruptcies for some.  In June 2016 the country was shocked by news that a 69-year-old shareholder of the troubled Banca Popolare di Vicenza killed himself after a steep drop in the bank’s share price wiped out his savings.

Renzi’s handling of the ongoing EU talks and current economic situation will be crucial, especially if MPS’s rescue plan fails.  He has staked his job on constitutional reforms that are being put to a referendum in October and he cannot afford any erosion in voter confidence.  It has been suggested that a loss for Renzi could mean a loss for the EU: the Eurosceptic M5S party has been gaining strength and is waiting in the wings.  However, Italy’s situation is unlikely to result in a UK-style ‘Exitaly’. Public opinion does not currently support the idea and even M5S has rejected the prospect of leaving the EU, although it has called for a referendum on membership of the Eurozone.   Nonetheless, the EU can hardly afford to ignore the situation in Italy, which (excluding the UK) is now its third-biggest economy.

The excessive amount of bad debt on Italian banks’ books is a reflection of the state of the country’s economy.  In the aftermath of the global financial crisis, large numbers of corporates and households were unable to repay loans, while fraud and mismanagement in the financial sector compounded the banks’ financial problems.  Property prices have stagnated for years – the construction and real estate sectors alone account for over 40% of bad debts – and there is no clear trajectory out of the crisis.

Italy will only stand a chance of getting back on its feet if international investors take an interest.  External capital is required to unburden the banks, drive up property prices and boost ailing sectors like retail and construction. But there are valid reasons why investors are hesitant when it comes to Italy, including endless bureaucracy; a slow and complicated legal system that appears to favour anyone wealthy and patient enough to drag a case out beyond the statute of limitations; and corruption levels on a par with South Africa and worse than Saudi Arabia, according to Transparency International.  Investing in Italy is not for the faint-hearted, but for anyone willing to test the water – banking stock could hardly get cheaper.