Italy’s Teetering Economy May Trigger EU Battle

Italy is seen to be on the brink of an economic and political crisis which has been brewing for some time. The country’s banks has on its books bad loans that now amount to over €360 billion, weighing down the economy and hampering credit to consumers and businesses that need it. Over 18 percent of bank loans in Italy are sick, making it amongst the countries with largest non-performing assets. French banks’ have around 5 percent of bank loans while UK banks have less than 1.5 percent.

Countries such as the UK, Spain and Ireland who have had to deal with bad loans have typically focused on cleaning up the banks’ balance sheets quickly. But Italy has so far avoided taking any action since it wants to protect the largest chunk of bank investors, the households.

Households make up a large portion of bank bond holders in Italy, holding almost €235.6 billion of bank bonds and would suffer significantly if the banks losses are dealt with. This reluctance has resulted in the malaise now spreading to other parts of its economy, setting up a clash with the European Union, which is likely to have political ramifications.

Speaking on the matter, a lawyer in the know said that the bad loans crisis in Italy had potential to be a bigger risk than the Brexit. He said that while the Greeks had willingly taken up austerity measures in order to remain in Europe, Italy may not be willing to do so. If the Italian government continues to protect the bondholders at all costs despite EU rules which say that bond holders rather than the tax payer must bear the cost of recapitalization, it could lead to further instability within Europe.

The International Monetary Fund (IMF) has said in its assessment that the country cannot prosper since the banking sector is sick. The IMF has highlighted that productivity is still low with debt climbing and has projected that the country’s economy will not be able to achieve its pre-crisis level until 2025. The cost of recapitalizing the banks has been put at €40 billion which might necessitate retail bondholders’ participation.

In a statement, Roberto Henriques at JP Morgan said,

The risk of bailing in retail bondholders is that the domestic bond market, which is important for funding Italian banks, could potentially shut down. At the margin, the media coverage of any subsequent losses for retail bondholders might also undermine retail depositor confidence in the same institutions, with the potential for some deposit outflows

The country is exploring various routes including ignoring EU requirements and releasing a taxpayer-funded bailout to banks or adopting the Greek option where the bondholders participate in the clean up with their bonds being switched to shares.