Italy’s bank saga spreads trouble wide

Posted on August 10, 2016

epa05286765 Italian Premier Matteo Renzi speaks at Florence's Niccolini theatre in Florence, Italy,02 May 2016. Renzi said his government was about to tackle its biggest challenge yet, as he kicked off the campaign for a yes vote in this autumn's referendum to ratify its Constitutional reforms to overhaul Italy's political machinery. EPA/MAURIZIO DEGL' INNOCENTI©EPA

Italy’s banking crisis risks undermining prime minister Matteo Renzi’s legitimacy

Much has been written about the risk that Italy’s weak banks pose to the rest of the eurozone’s financial system. The risk is real but it obscures a greater one, which could derail the zone’s political as well as economic future.

Underlying Italy’s banking sector woes is the lack of growth that afflicts the single-currency countries, contributing to a political malaise that could rob Matteo Renzi, Italy’s prime minister, of his legitimacy — and thus the ability to push through reform.

    The band-aids that have been applied to Italy’s banks may have succeeded in staving off temporary crises, but they have done little to address these underlying challenges.

    Last week, banks and insurers pledged €1.6bn in new money to Atlante 2, a fund set up by the Italian government to channel private sector money into rescuing the banks. The fund has backstopped capital raisings at the country’s weakest banks and should be enough, for now, to tide over Monte dei Paschi di Siena, Italy’s third-largest lender and the worst performer in July’s European-wide stress tests.

    This will allow the Renzi government to sidestep, temporarily, its most pressing dilemma: whether to use public money to bail out MPS, and fall foul of Brussels’ rules, or let the bank’s bondholders, including thousands of small retail investors, take the hit.

    Who knows what arm-twisting by the government persuaded contributors to stump up money for Atlante. Some pension funds balked at the last minute, but enough corporate allies were leaned on to get it out of a tight hole.

    It may be enough to soothe the market for a while but Atlante will not provide a longer-term solution. MPS’s woes are symbols of a wider malaise. The sector is weighed down with €360bn of problematic loans, equivalent to a fifth of gross domestic product, and Atlante has neither the firepower nor the tools to address a challenge on this scale.

    The problem is not just an Italian one. The Centre for Economic Policy Research suggests that, for the EU as a whole, non-performing loans were more than 9 per cent of GDP at the end of 2014, equivalent to €1.2tn and more than double the level in 2009.

    The reason the numbers have deteriorated, in Italy as in the rest of the eurozone, is because bad loans are the iceberg above the water. Under the surface lurks a bigger problem: a persistent lack of economic growth. Italy inched out of recession last year but the International Monetary Fund recently estimated that its economy would not return to pre-crisis size until 2025. Thousands of small and medium-sized companies have gone under, taking with them the bank loans on which they depended, as well as demand for lending. The banks’ challenges do not just affect Italy’s economic prospects; they have the potential to derail its political future.

    Mr Renzi has committed to holding a referendum on constitutional reform in the autumn which, if passed, will allow the government to make its new electoral system fully effective. The reform would strip the Senate, the upper house, of most of its powers and drastically cut its numbers. The plan is the linchpin of Mr Renzi’s broader reform programme.

    If the referendum goes against him, Mr Renzi has said he will resign, a self-defeating announcement that has effectively turned the vote into one on him personally as well as his government’s record. This is always a danger with referendums, and making explicit the link between Mr Renzi’s future and the vote’s outcome will only encourage the people to use the ballot box to punish the administration.

    They will want to do so because, like much of the voting public across Europe, they are fed up. The economy is growing too slowly to deliver much tangible benefit. Meanwhile, the electorate is distracted by endless stories about corruption in the political elite.

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    The bank saga has contributed to this sense of sleaze and backroom deals between politicians and business. MPS, backed by local dignitaries and already bailed out twice after fraud and mismanagement scandals, is one aspect of this sorry tale. Others include the wiping out of junior creditors in four small banks last December. Many voters believe the government helps business to the detriment of small savers, a narrative given heft by the suicide of an affected pensioner, and the fact the vice-chairman of one of the banks in question was the father of a cabinet minister.

    Anti-establishment disgust has already led to significant gains by the populist Five Star Movement, which won in Rome and Turin in recent local elections. It has led to a fall in support for Mr Renzi’s reforms. Opinion polls suggest voters’ intentions in the referendum are very finely balanced.

    The consequences of a No vote would be severe. Constitutional reform will, at the least, be delayed, leading to an untenable situation where the new electoral system has been applied to the lower chamber, but not to the upper one. A caretaker administration would be ineffectual. If early elections are held, they are unlikely to deliver a new government with a pro-reform mandate. The immediate as well as the long-term casualty will be growth.

    This does not just matter to Italy. The danger of its banks’ woes spreading further has been much commented on. But a No vote could deal an even more serious blow to the eurozone’s prospects — political as well as economic.

    sarah.gordon@ft.com

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