Italian policy makers get serious after 30% bank share plunge
- Italian banking shares dropped 30% in the first months of 2016
- Policy makers have taken measures to revive the Italian banking sector and improve governability of the country
- These measures have the potential to support the economy, yet continued policy action is necessary to significantly revive economic growth (potential)
- The short-term outlook for further bold, but necessary, policy measures is rather bleak
The government has introduced several reforms and measures in order to quell recent financial market turbulence (the FTSE All share banks index fell by 30% in the first few months of 2016). Part of the stress results from the sector’s weak asset quality: the stock of non-performing assets amounts to EUR 350bn or 24% of total loan book and 21% of GDP. The recently announced reforms add to steps taken over the past year to improve banking sector stability.
Most recent reforms include:
(i) The introduction of a government guarantee scheme to help Italian banks to separate NPLs from their balance sheets by securitising them into Special Purpose Vehicles (SPV). Each bank will have to set up its own SPV and the bad loans will be packed into senior and (mostly) junior tranches. The former are eligible for a government guarantee, if they meet a few specific requirements. While the intention is right, it is too soon to tell whether this will help. Healthy banks have already isolated their own NPLs internally and may see no benefit in paying for the guarantee. Especially weaker banks might be unable to find buyers for their NPLs. Moreover, the price for the guarantee on senior tranches might absorb possible gains from the better valuation of the portfolio after offloading the NPLs.
(ii) To deal with the possible lack of buyers for these tranches, but also to ensure funding for the recapitalisation of Italy’s weakest banks, the government has arranged the set-up of the privately funded fondo Atlante. Supposedly the fund can initially count on EUR 4 to 6bn, partly from healthy Italian banks and a minor contribution of EUR 300mln by the state’s lender. As the operational modalities are as yet unknown, it is too soon to speculate on the fund’s success, although EUR 4 to 6bn looks small compared to the aggregate NPL volumes in banks’ balance sheets. Moreover, it is not certain whether or not the EC will approve the structure within its state aid rules. Finally, the fund could also backfire as it increases the interconnectedness between financial institutions and it transfers money from healthy banks to ailing banks.
Over the past year, the government also changed the insolvency law to induce banks to write off bad loans faster and to create secondary market demand for non-performing loans (NPLs). While welcomed, these have so far appeared insufficient; more plans are to be announced soon. Yet, the necessary solution might be a complete overhaul of the slow judicial system, which is not expected, at least for the short run. In order to improve the efficiency of the Italian banking sector, the government also introduced a reform of the small Popolari banks last year, to stimulate consolidation of the sector. There has only been a single merger so far, but that might set a precedent.
Constitutional overhaul to speed up decision making
To speed up decision making and further economic reforms, Renzi has fought for a constitutional overhaul. On April 11th, Parliament gave its final approval to curb the powers of the Senate. As it concerns a constitutional reform, a referendum will ultimately determine whether the bill enters into legislation. The referendum is expected in October. We believe the reform will pass, which marks a great win for Renzi and in our view (potentially) also for Italy. As the overhaul likely increases political stability and improves governability of the country.
Italy is losing its (reform) appetite
The government still has multiple potential reforms on the agenda as the country still has a variety of challenges to deal with, such as an inefficient public administration and a weak and slow judiciary system (see also Kalf and Wijffelaars, 2016 (in Dutch)). However, the probability that the government can / will tackle all these issues, in the short-term, are rather muted, for several reasons. For example, vested interests remain large, the system is inert and multiple layers of (rather inefficient) governments prevent intended implementation of passed legislation and reforms. At the same time, Renzi only has a small majority in parliament and support for the government has dropped over the past year. Accordingly, threats to call fresh elections to convince both coalition and opposition parties have lost weight. Especially, populist eurosceptic parties have gained support owing to the ongoing economic malaise, the rather unpopular labour market and education reform, and not least the lack of European support in the refugee crisis. In order to regain support, Renzi will expectedly refrain from further major reforms, pick fights with Brussels and slow fiscal adjustment.