Italy’s problems have seemingly never gone away.
With a viscous cycle of rising trade protectionism and inflation slowing economic growth, a gross debt burden totalling 130% of GDP and a populist-left government planning to increase budget spending, a recipe is forming for financial distress, especially if factoring in a fragile banking system.
Bank stability is one of five economic risk factors included in Euromoney’s country risk survey, and it remains a concern for Europe generally, according to analysts, despite stronger economies, and tighter capitalization and liquidity requirements since the global financial crisis:
Italy remains the biggest concern of all, from a systemic risk perspective, with a high level of non-performing loans and rating decisions due over the next few weeks.
Deteriorating credit quality has increased default risk, a recent report shows, and illustrating this is Italy’s bank stability score, which has barely improved at all during the past five years.
Its problems are a more significant threat than the rapidly unfolding Turkish crisis, argue many of ECR’s survey contributors – among them Constantin Gurdgiev, professor at the Middlebury Institute of International Studies.
“There are two key reasons for this conclusion,” he says. “The quantum of problematic assets outstanding in both cases, and the degree of the two economies’ inter-links with the global economy.”
Italian banks are receiving support from the European Central Bank (ECB), maintaining record-low interest rates and expanding its balance sheets with government bonds, and without this the banks would be forced to address the problems more directly.
“The Italian banking system is facing pressures through 2019, potentially amounting to more than €300 billion, putting the Turkish crisis into a distant second when it comes to the risks to the global economy,” says Gurdgiev.
There are potential shocks to Italy from monetary policy tightening and rising bond yields, notably given the economy is also more important than Turkey’s, as the third largest in the eurozone, and its assets are more widely held by banks and institutional investors.
Banca Carige is a huge concern, says ECR contributor Tom Kinmonth, senior fixed income strategist at ABN Amro.
“On July 22, Banca Carige was asked by the ECB to submit a plan to raise capital or consider a merger,” he says. “In recent months, the chairman and a number of board members have left the struggling Italian lender and now a legal case has also arisen.”
Kinmonth believes it will be tough for the bank to issue the tier-2 debt needed by the ECB, and as merger talks are often chaotic in Italy, it could bring volatility across Italian markets.
In May, in response to the political crisis and plunging bank shares, Italy’s central bank governor Ignazio Visco said the country was just a few steps away from “very serious risk of losing the irreplaceable asset of trust”.
Those words are likely to echo loudly as investors fret over the country’s third largest lender Banco BPM, says Kinmonth, who warns that the bank’s recent issue of a five-year covered bond at a very wide level provides “the first sign investors may be distancing themselves from Italian banks, which does not bode well for the large amount of funding they will need”.
This comes amid wider concern for the balance sheets of other banks urging sector consolidation, certainly among smaller institutions that the government seems to be blocking, against the advice of European institutions.
Any contagion from a shock in Italy would certainly have more of an impact on Europe, and globally, than the crisis in Turkey, compounded by the fact Brexit and trade wars are creating huge uncertainty.
Commerzbank economists note the government’s budget plan for 2019 will show to what extent it will stick to expensive election promises and how much the budget deficit will increase as a result.
“There is a threat of serious conflict within the government and above all with the EU, creating continued unrest for the markets,” they say.
Many of ECR’s Italian experts concur.
As for Gurdgiev, he believes the catalyst may come in September or October, when the markets come back to normal trading focusing less on emerging markets, and the ECB returns to its forward guidance.
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