As with many European countries these days, there is strong pressure to increase credit availability in Italy, with the conviction that this could be the way to relaunch investment and economic growth. Nonetheless, Italian banks remain cautious about underwriting new business.
In fact, the burden of non-performing loans (NPLs) represents the main reason for the inability to extend new credit to new lucrative businesses. A NPL is a loan unable to repay the capital and the accrued interest due to creditors. Non-performing loans consists of real estate taken by foreclosure, loans that are 90 days or more past due and loans which have been placed on non-accrual.
Whenever the loan portfolio of a bank is not correctly diversified, there may be a high-risk profile and potential for some form of faliure. Given the important role that a bank carries out – it does not only provide loans, but gathers citizens’ savings too – the government should try to preserve such savings and protect them from such bad management risks.
Essentially, since the problem involves the entire financial and social system, a possible solution could be the creation of a central organisation such as an asset management company, where the involved parties including the banks, the regulating body and the government get together to find pragmatic solutions. This takes the form of a bail-out. Alternatively, banks could be left alone – a sort of bail-in – to manage their own bad assets by giving them special advantages and incentives.
The idea of a Bad Bank
The use of the term ‘bad bank’ goes back to the years following the 2008 financial crisis, when the Obama administration had the idea to create a specific bank to unburden institutes from their toxic bonds, which were too illiquid to sell back to the market immediately. Therefore, a bad bank is a bank set up to buy the bad loans of a bank with significant non-performing assets. Practically, the original bank is divided in two parts: on the one hand there are good assets such as high quality credits and deposits, on the other hand there are all the credits towards subjects unable to pay back. By transferring the bad assets to the bad bank, the institutions clear their balancesheet of toxic assets. Shareholders and bondholders, but not depositors, finally stand to lose money from this solution.
Looking to the topic from the other point of view, many companies see a business opportunity in buying NPLs since they buy them with a lucrative discount. In fact, companies pay from 1% to 80% of the total loan and become legal creditors.
The European experience with regards to bad banks is a story of both success and failure. Each experience is shaped on the financial system of the specific nation so much that in Spain, Ireland and United Kingdom it has been a success, while in Austria and Slovenia results have been disappointing.
The Italian situation
During the last few years, Italy experienced a double-dip recession as a result of a long contraction in demand, with the second stage being more troubling compared with other countries. The level of bad credits is not the Cipro’s one, where they are almost the half, but non-performing loans have quadrupled between 2008 and 2014 op to 327 billion euros.
“We are thinking about an asset management company to accelerate the Italian market of NPLs”
Ignazio Visco, Governor of Banca d’Italia
As a matter of fact, compared with the UK, Spain and Ireland, NPL market activity has been weak and the bid-ask spread between the carrying value of loans and the price expectations of investors is confirmed as the principal barrier preventing the completion of NPL sales.
On the 23rd November, the Italian government approved the “Save banks plan” to save four Italian regional banks. This plan amounts to the creation of four bridge-banks that inherit only healthy assets and, at the same time, the creation of only one bad bank with the bad credits of the four institutions. The new vehicle take upon itself 8.5 billion euros of unhealthy credits, devalued to 1.5 billion euros, that will be sold to specialised Private Equity institutions.
The operation is neither a bail-in, nor a bail-out, since the sum of 3.6 billion euros to save the banks is supported by other healthy Italian banks. However, the Italian government through the “Cassa depositi e prestiti” covers a role of guarantors.