Global Glance: August 15, 2016
A quick look at intriguing international stories
By John Bostwick, Managing Editor, Radius
Welcome back to Global Glance. This week we look Italy's troubled banks.
The Italian Bank Crisis: Is Europe Headed for a Doom Loop?
Doom loop isn’t (yet) the name of a Brooklyn electronica band, but rather a catastrophic economic scenario that could develop in Europe as a result of the poor state of Italian banks. These banks hold a huge proportion of so-called non-performing loans (NPLs), or bad debt. As an April Bloomberg.com article explains, Italy’s banks “have more non-performing loans than in any other major European economy.” The NPLs impede their ability to issue new loans or potentially merge with other institutions.
Another Bloomberg piece last month lays out the basics of the situation. Crucially, in the aftermath of 2008’s financial crisis, banks in Spain, the US, Ireland and other countries were buoyed by taxpayer bailouts. Italy’s leaders, on the other hand, decided to eschew bailouts, and, as Bloomberg puts it, “waited for an economic recovery that never came.”
Yet another Bloomberg article on the subject explains that Italian banks no longer have the option of taking taxpayer bailouts. As of January, EU laws “bar governments from channeling public money to troubled institutions in most circumstances.” As a result, private investors may be forced to pay — or "bail in" — failing Italian banks.
As the second Bloomberg piece notes, bail-ins are appealing in theory but deeply problematic, since not all private investors are Maserati-driving, Barolo-swilling bigwigs. In fact, Bloomberg points out, many are “middle-class individuals who have put their savings in bank bonds.” The article explains that “bondholder losses at four small banks in November sparked protests by savers, a nationwide selloff of bank debt and one suicide.”
For an interesting and informative take on the Italian bank mess check out this interview with Franklin Allen, a professor at the University of Pennsylvania and at Imperial College in London. The dialogue was published on the Wharton school’s website last month. Its excellent introduction explains that Italy is the EU’s third-largest economy, and a run on banks or substantial loan defaults there could affect the entire eurozone, where profits are thin due to low interest rates and other factors. “What’s more,” the introduction adds, “companies in Europe depend on bank loans far more than in the US, so struggling banks can mean that even successful companies face a credit squeeze.”
The situation is made more precarious by the fact that Italian banks are “heavily invested in government debt,” which is about 135% of Italy’s GDP. Obviously this heavy debt would make a state bank bailout difficult, and in any event EU rules now “require European banks to bail-in shareholders and bondholders – use their holdings to recapitalize a troubled bank — before any taxpayer-funded bailout can occur.” The Wharton piece adds (depressingly and predictably) that many small investors in Italy that may face paying for a bail-in “were duped into buying bank bonds under the impression that they were as safe as insured deposits.”
Here are some snippets from Professor Allen’s comments:
- “I think everybody agrees that it’s fine to bail in the shareholders, but it’s problematic to bail in these small bondholders.”
- “It seems that if there are bail-ins, the Italian government is going to recompense the small savers who have this kind of debt. But we get back to this problem of, can they afford to do that? And who exactly will get compensated?”
- “I think these systemic problems can arise out of nowhere or out of small beginnings and take over very quickly. That’s what we saw in the financial crisis. And I think this problem with the Italian banks has that potential, and that’s why it’s so worrying and so important.”
- “That’s always the underlying issue — that people will start running both on the banks and the government. That’s this doom loop.”
Allen also notes that in October Italy will hold a referendum that could significantly alter the country’s political system. A “No” vote will likely lead to the resignation of Prime Minister Matteo Renzi, who sees the proposed constitutional reforms as essential to economic reform. Speaking of referendums, Professor Allen does not predict that Italy will exit the EU, but that the country “may hold a referendum on pulling out of the eurozone … [which] is a reason to be worried about what’s going on in Italy at the moment.”
Another cause for concern: After markets closed on Friday, August 5, DBRS, a Canadian credit agency, announced that it will put Italy’s “A” credit rating under review and possibly downgrade it. An article in Reuters explains that the agency’s announcement was made in light of Italy’s coming referendum, “pressure on Italian banks” and the country’s high debt levels relative to GDP. Reuters reports that the “the unexpected move ‘irritated’ the Economy Ministry of Pier Carlo Padoan,” and that a downgrade following a review would “raise the cost for Italian banks of using government bonds as collateral for taking loans” from the European Central Bank. Reuters says that the review will likely take about three months and that the Economy Ministry “is considering whether to appeal against DBRS’s move, which comes outside of its regular schedule of ratings reviews.”
The Italian banking system did get some good news this month. According to an August 5 Financial Times report, banks and insurers pledged to give €1.6 billion to the Italian government’s private fund, Atlante 2, which has been established to alleviate bad bank debt. The fund will also receive an €800 million injection from Atlante 1 (another fund to help embattled banks) and possible additional contributions from small banks and other private institutions. This relief is critical in the short term, as Monte dei Paschi di Siena (MPS) — Italy’s third-largest bank and the oldest bank in the world — is on the brink of collapse due to its non-performing loans. The Times points out that MPS “was the worst performer in European-wide banking stress tests” conducted last month.
While obviously welcome, the Times explains that the combined €2.4 billion so far committed to Atlante 2 is “far is below an expected minimum target of about €3 billion” and is a mere “precursor to a €5 billion capital raising by the end of the year that Italian banking executives and government officials are counting on to save it from possible collapse and state intervention.” According to the recent stress test, about 17 percent of Italy’s largest banks’ holdings are non-performing loans, which is more than three times the average across EU member states.
An opinion piece in the Times last week by Sarah Gordon dismisses the Atlante 2 fund as a “band aid” to Italy’s problems, given that the country’s banking system is saddled with about €360 billion of bad loans. The loans plaguing Italy and the rest of the eurozone are, she says, the tip of the iceberg, with the larger problem being “a persistent lack of economic growth.” She notes that the International Monetary Fund predicts that Italy’s economy won’t reach pre-crisis levels for another decade. She worries that a “No” vote in the October referendum could further impede economic growth and prove even more harmful to the eurozone than the Italian banking crisis.