As Italian banks continue to fall like dominoes, it is rapidly sending signals to policymakers – setting off financial panic all over Europe, unlike anything we have ever seen before. The condition of Italian banks has been alarming with shares of Italian corporates losing 25% of their value.
Holding its reputation of being the most troublesome Italian bank after two bailouts by the Italian government since 2009, Monte dei Paschi decimated 4.7% of its value despite its plummeting growth of 56% at the beginning of the year. But Monte dei Paschi is not the only one; Banca Carige’s shares lost their value by 8% despite its plummeted growth of 58% at the beginning of the year. This is the real-life definition of a financial crisis. The fact that the severity of the problems in Italy keeps accelerating does not only worsen Italian financial position but the EU as a whole.
What makes the Italian banking performance so worrying?
The urge to come up with a perfect plan to save the Greek government-debt crisis by the European Central Bank (ECB) was witnessed by the rest of the world. Greece is just the 44th largest economy in the world compared to the Italian economy standing at 8th place in the world’s largest economy ranking with their government debt to GDP ratio sitting as high as 132%, as measured by Eurostat. It is impractical to question whether the rest of Europe can handle the full meltdown of Italian banking system if it were to collapse. Unfortunately, this is exactly what is happening. Italian banks are suffering the effects of non-performing loans (NPLs). This makes the foreseeable Italian financial collapse the greatest threat in the world.
The heart of this crisis lies in the disturbing level of NPLs on bank’s book ranging from 17% to 21% of total lending, which is 12% of Italy’s GDP. However, nightmares do not end there; bad loans constitute 30% of individual bank’s balance sheet. This is extremely harmful to the health of the banking system.
Also, what brought more concerns for the Italian financial sector health was the fact that ECB demanded that by the end of March, Banca Carige has to come up with a new strategic plan and additional funding to strengthen the financial position of their balance sheet. This tragic news gave rise to high volatility and eventually causes trading to come to a halt resulting in a tremendous loss of investor confidence – both for foreign and domestic investors.
Italian banks then came up with plan A and suggested a “bad bank” solution where unsettled institutions get rid of their NPLs to a detached state-backed entity where the assets would be managed while protecting the sector from the damaging effects of high level of NPLs. Unfortunately, to shield the taxpayer from uncompromising losses, new rules set by the European Union prohibited the use of this state aid to bailout banks. So they came up with a plan B – a “bail-in.” With plan B, banks are allowed to revive their balance sheet by selling their NPLs to investors along with attracting government guarantees for the smallest risky fraction of debt.
What’s tricky is the fact that the price of the securities must be set at the market rate. Moreover, the rate of mark to market (MTM) for Italian NPLs settles at someplace between 20% to 50% of the existing listed price. This results in enormous write-downs for banks and damages bondholders during the 2015 “bail-in” application for four Italian banks. These losses are not partial to financial institutions; investors in the retail industry and individual both suffer due to a substantial share of ownership of this debt as savings for retirement.
Is the Italian banking system fiasco much worse than Greece? Yes.
Although Italy comes second in the worst debt-to-GDP ratio after Greece, what made the situation worse is the fact that Italy is the 8th largest economy in the world. This fast approaching failing Italian financial crisis has a high potential to cause significant loss across the European Union – much worse than Greece.
To conclude, this foreseeable financial meltdown will cause a domino effect of market turmoil and impose high possibility to harm financial positions in fragile neighbouring economies within the EU due to rough decisions made by policymakers to combat this crisis in panic. What’s worse is the fact that there cannot be another crisis in the Eurozone right now – if banks collapse, the euro will collapse too. Will the Italian banking system be the root of the next financial crisis? Only time will tell…