Saturday 22 October 2016

First Brexit domino falls as Italy eyes €40bn bank rescue

Ambrose Evans-Pritchard

Published 28/06/2016 | 12:30

Prime Minister Matteo Renzi (left). Photo: Getty Images
Prime Minister Matteo Renzi (left). Photo: Getty Images

Italy is preparing a €40bn rescue of its financial system as bank shares collapse on the Milan bourse and the powerful after-shocks of Brexit shake European markets.

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An Italian government task force is watching events hour by hour, pledging all steps necessary to ensure the stability of the banks. “Italy will do everything necessary to reassure people,” said premier Matteo Renzi.

“This is the moment of truth we have all been waiting for a long time. We just didn’t know it would be Brexit that set the elephant loose,” said a top Italian banker.

Read more: Explained: Have Ryanair's O'Leary and the world's richest 400 lost big in Brexit market rout?

Italy government debt to GDP
Italy government debt to GDP

The share price of banks crashed for a second trading day, with Intesa Sanpaolo off 12.5pc, and falls of 12pc for Banka MPS, 10.4pc for Mediobana, and 8pc for Unicredit. These lenders have lost a third of their value since Britain’s referendum.

“When Britain sneezes, Italy catches a cold. It is the weakest link in the European chain,” said Lorenzo Codogno, former director-general of the Italian treasury and now at LC Macro Advisors.

The country is the first serious casualty of Brexit contagion and a reminder that the economic destinies of Britain and the rest of Europe are intimately entwined. Morgan Stanley warned in a new report that eurozone GDP would contract by almost as much as British GDP in a "high stress scenario".  

Read more: New Brexit blow as Fitch downgrades Britain's credit rating

Italian officials are studying a direct state recapitalisation of the banks, to be funded by a special bond issue. They also want a moratorium of so-called ‘bail-in’ rules and bondholder write-downs, but these steps are impossible under EU laws. Mr Renzi raised the subject urgently at a meeting with German Chancellor Angela Merkel and French president Francois Hollande at a Brexit summit in Berlin on Monday.

“There has to be a suspension of the bail-in rules and state aid rules at the highest political level in the EU, otherwise I don’t see how this can work,” said Mr Codogno.

Unlike the eurozone debt crisis in 2011-2012, there is no serious trouble yet in the sovereign debt markets. The ECB is effectively capping yields under quantitative easing.

The stress gauge in this episode is the health of the private banks. The Euro STOXX index of bank stocks has collapsed by half since last July, and is now probing depths seen in the white heat of the debt crisis. British bank shares have also plummeted since Brexit but this has no systemic implication so far. It chiefly reflects recession fears, and potential loss of access to the EU market for business.

Italy’s banks are the Achilles Heel of the eurozone financial system. Non-performing loans have ratcheted up to 18pc of total balance sheets as a result the country’s slide into depression after the Lehman crisis.


The new bail-in reform this year has brought matters to a head, catching EU authorities off guard. It was intended to protect taxpayers by ensuring that creditors suffer major losses first if a bank gets into trouble, but was badly designed and has led to a flight from bank shares. The Bank of Italy has called for a complete overhaul of the bail-in rules.

It is now almost impossible for Italian banks to raise capital. They are caught in a pincer as the ECB simultaneously demands compliance with tougher capital adequacy buffers, in some case demanding fresh infusions of capital three or four times.  Mr Codogno said the ECB is unwittingly destabilizing the banks in an overzealous attempt to make Europe’s banks safer.

Italy is now paralyzed under the existing eurozone structure. Analysts say it desperately needs a US-style bank rescue along the lines of the ‘TARP’ in 2008, which used federal funds to mop up bad assets and stabilize the banks. This is forbidden by the eurozone.

The government introduced a €5bn rescue fund called Atlante earlier this year, but this was funded largely by the banks themselves rather than the state and has been overwhelmed by events. 

Mr Codogno said Italy is caught in a low-growth trap that is slowly eroding debt dynamics. “I don’t think the Italian system is about to blow up. We could muddle through for years, but we need to get out of this loop,” he said.

Hedge fund veteran George Soros warned that Italy faces the risk of a “full-blown banking crisis” that could bring the rebel Five Star Movement to power as early as next year. 

The banking squeeze has become politically explosive in Italy after thousands of small depositors were wiped out at four regional banks late last year. They were classified as junior bondholders, even though most of them were just ordinary savers who did not realize what was being done with their money.

Mr Renzi may be forced to take matters into his own hands and enact a unilateral sovereign rescue of the Italian banking system in defiance of the EU, unless he wins concessions soon from Brussels. Those who know him say he will not go down in flames for the sake of European ideological purity.

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