The Strategist

Italy to Create a "Bad Bank"

01/27/2016 - 14:58

Italy coaxed the EU to create a "bad bank". Total debt of Italian banks exceeds 200 billion euros. For the first time since 2010, Rome has made a real breakthrough in solving this problem. For several years, the stumbling block was the EU rules prohibiting direct state aid to banks. Now, resourceful Italians figured out how to work around them delicately without irritating the European Commission.

Dave Kellam via flickr
Dave Kellam via flickr
The Italian authorities will release special security papers for the country’s commercial banks. Price of such instruments will not be fixed, but determined by the market as banks will have the right of free resale. Ultimately, the government will transfer no well-defined financial tranche, i.e. formal EU rules will remain undisturbed.

In addition, Rome was able to get permission from Brussels to securitization under the new agreement. Italian banks are now free to "pack" bad debts into new bonds and resell them. The example of American mortgage crisis in 2007 clearly shows that such complex bonds operations in the future may lead to catastrophic consequences. Yet in the short term, the Italian financial sector will be able to solve their problems - or, at least, pass them to the next generation of top managers.  

The Italian authorities have their own interest in it, too. The government will formally relieve banks balance sheets, turning bad debt into new realizable bonds. This will significantly speed up new lending, which Italy's economy desperately needs. The rate of growth of the Italian GDP amounted to 0.4% in the first quarter of 2015, but drooped twofold in the third quarter. Positive effects in the Italian real economy are expected not only by the Prime Minister Matteo Renzi, but also by Margrethe Vestager, European Commissioner for Competition.

Bad debts on the Italian banks’ balance sheets are estimated at 201 billion euro - 11% more than last year. This estimate includes only the worst from all categories: loans to debtors, officially declared bankrupt. If we assume months long delays, the picture is quite grim. In general, bad debts the country reached 10.4% of the total volume of loans granted - this is anti-record since 1996.

Finance Minister Pier Carlo Padoan and European Commissioner Margrethe Vestager formally gave a quietus to many years of talks. Experts believe that the real breakthrough was made by Prime Minister Matteo Renzi during his Davos weekend. Italian Prime conducted intensive talks with senior representatives of the European Commission behind closed doors.

European officials have tempered justice with mercy. Italy decided to liquidate its financial problems during the current period of loose monetary policy. In addition, the ECB hinted at further stimulating in this spring. The difficult maneuver with the Italian bank debt is still possible to be performed with the current low rate of the Central Bank. Once the ECB begins to tighten the screws, sale of many questionable securities and - even more so - increase in the real sector lending at unattractive rates will be very problematic.