Source: Euro Pacific Capital, by John Browne
On December 7, 2016, Italy’s Prime Minister Matteo Renzi resigned following defeat in a national referendum, that he had supported, that would have changed the country’s parliamentary system. The development, which represents just the latest sign of anti-EU sentiment spreading throughout Europe, was felt acutely by Italy’s troubled banking sector. In particular, the Banca Monte dei Paschi di Siena (MdP) has been teetering on the brink of collapse and now may stand as a case study that may be encountered by other EU member nations.
The advent of the euro currency allowed Eurozone member countries, even those with poor financial health like Italy, to borrow at far lower ‘Germanic’ interest rates than their respective national credit ratings would have allowed. In turn, national borrowers were able to tap into the vast sums of liquidity created under central bank quantitative easing (QE) programs at astonishingly low, and sometimes negative, interest rates. Predictably this has led to a massive misallocation of capital, and billions in potentially non-performing loans.
The problem for Italian banks became particularly acute when the fall of the Renzi government raised the possibility that a new Government could seek to lead Italy out of the Union and bring back the lira to Italy. With the return of its own currency, future Italian governments could devalue at will in order to pay the country’smounting debts. If faced with the possibility that their euro-denominated deposits could be transformed into shrinking lira deposits some could be convinced to transfer funds into German banks where they would face no such peril (EU laws present no obstacles to cross-border banking). This is a clear recipe for a banking default.
According to a 2016 IMF working paper (WP16135), Italian bank nonperforming loans had tripled since the crisis of 2008. It blamed “A combination of over-indebted corporates following the sharp crisis-related drop in output, banks generally low in capital buffers, a highly complex legal system of corporate restructuring and insolvency, lengthy judicial processes and a tax system that until recently discouraged NPL write-offs … .” On September 13th, Bloomberg estimated Italy’s nonperforming loans at $394 billion through March or 16.1 percent of Europe’s total, based on data from the European Central Bank (ECB).
Furthermore, a relative lack of economic opportunity and a massive increase in inward migration has caused a marked increase in emigration from Italy, particularly among young males. The recently released OECD 2016 International Migration Outlook recognizes that, “The public is losing faith in the capacity of governments to manage migration.” Italian emigration more than doubled between 2010 and 2014. This contributed to an erosion of the bank deposit base.
Italy is one of the world’s most indebted nations with debts estimated in 2015 at over $2.4 trillion or 130 percent of its GDP, about half of which is comprised of government spending. Therefore, Italy is not well placed to finance a potentially devastating and fast developing domestic banking crisis.