Italian banking – a Brexit-fueled calamity

Thu 14 Jul 2016

Brexit continues to dominate the political and financial world across Europe and beyond as people wrestle with its impact. But there’s another massive storm on the horizon for the EU that has been brewing for some time and Brexit may well have brought forward its impact: The Italian Banking Crisis.

As reported in the Wall Street Journal on 4 July, “Britain’s vote to leave the EU has produced dire predictions for the U.K. economy. The damage to the rest of Europe could be more immediate and potentially more serious. Nowhere is the risk concentrated more heavily than in the Italian banking sector.”

The share price of Italian banks plummeted following the Brexit decision, with Italian banks now having lost more than a third of their value since the beginning of the year. As one Italian banker has said, “This is the moment of truth we have all been waiting for a long time. We just didn’t know it would be Brexit that set the elephant loose.”

Italy is holding a referendum on wide-ranging reforms to its Senate, the upper house of parliament, in October. If approved they would the government to push through laws aimed at improving the country’s economic competitiveness. If not, and at risk of doom mongering, political instability, financial problems and recession are firmly on the cards.

Not good – to say the least – for Italy’s banking industry. Italian banks suffer from €360 bn of bad loans. According to the Bank of Italy as much as €200 bn could be insolvent and, of that, €85 bn have not been written down. The Italian banking crisis has started to make headlines in many major newspapers and featured on the cover page of the Economist this week. As Jim Reid, Global Head of Deutsche Bank’s Fundamental Credit Strategy Group noted earlier this week, “What Brexit has reignited and brought back to the forefront is the ailing and fragile state of the Italian banking sector”.

State intervention “cannot be ruled out” we heard the Governor of the Bank of Italy, Ignazio Visco say on 8 July. But “state intervention” is easier said than done these days. The single rulebook for the resolution of banks and large investment firms in all EU Member States has come into force as of 1 January 2015. These new rules are meant to harmonise and improve the tools for dealing with bank crises across the EU. They stipulate that shareholders and creditors of the banks pay their share of the costs through a “bail-in” mechanism (for more on this, follow this link).

The problem in Italy is that most of the shareholders and investors are retail customers.  To protect the interests of the private investors is in the interest of the Italian government.  Ultimately a bail-in of private clients could trigger a bank run and have far worse consequences.

On the one level, we could view Brexit and the Italian banking crisis as vying for the biggest issue facing the EU. But, in reality, they aren’t separate. They are complex problems made more complex by being most definitely linked. And the inter-relatedness of economic and financial issues is going to be an enduring characteristic of the post Brexit world.

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