One of the main long running themes of this website has been the problems and travails of the Italian economy. Back on the second of June I expressed the issue in this form.
I have taken a look at the annual numbers and in the year it adopted the Euro (1999) Italy had a GDP per capita of 26,353 Euro’s and in 2015 it was 25,479 Euro’s or 3.3% lower (2010 prices).
That still has the power to shock me and please take a moment to consider the impact of the fact that according to the official statistics the individual experience has gone into reverse both this century and in consequence in the Euro era. At that point I used the words of the Governor of the Bank of Italy which reinforced this grim message.
that Italy has the potential to recoup the growth gap it has accumulated in the last twenty years.
This made me have a wry smile at the latest report on the subject by the International Monetary Fund.
This growth path would imply a return to pre-crisis (2007) output levels only by the mid-2020s and a widening of Italy’s income gap with the faster growing euro area average.
This led to a flurry of lost decade style headlines many of which missed the fact that if we look back as I have described above Italy has been in such a situation for quite some time. Indeed whilst the economic forecast below is not great it is about as good as it gets for Italy.
Growth is projected to remain just under 1 percent this year and about 1 percent in 2017.
This backdrop has significance for the banking sector and the IMF put it thus.
It also implies a protracted period of balance sheet repair, and thus of vulnerability.
There was also some specific advice for the Italian banking sector.
To substantially reduce the stock of NPLs over the medium term, lower the cost of risk, and improve operating efficiency, Directors supported further measures, including more intensive use of out-of-court debt restructuring mechanisms; strengthened supervision; and a systematic assessment of asset quality for banks not already subject to the ECB comprehensive assessment, with follow-up actions in line with regulatory requirements.
That was quite a lot of advice! One can learn a fair bit by the amount of it and this clashed with the official view from Italy which is that there is no problem at all. We were told that the rescue fund would deal with the problems as we mused whether it would even last the summer. That story seems to be changing somewhat however.
Italian banks: So Fondo Atlante is seriously depleted thanks to no take up for new shares, so the solution? Fondo Atlante 2 with €5 to 6bn ( h/t Macroeconomics1 )
Mario Draghi responds
The ECB President was intimately involved in the past history of the Italian banks as both a bank supervisor and as the head of the Bank of Italy. These days of course he is involved but from more of a distance as he has a general overview from Frankfurt. Regular readers will be aware that I have long expected him to offer help to the Italian banks and yesterday we did get some hints. This was an interesting reply to a general question about the Portuguese and Italian banks.
We have in place rules of state aid, we have the BRRD, and as I said several times, these rules contain all the flexibility to cope with exceptional circumstances.
He took the opportunity to describe the rules whilst offering the potential get out of “exceptional circumstances” which made me think that Brexit could be used as such. That would be familiar Euro area policy in responding to a crisis for it rather than acting in advance. Later he became more specific.
On the first question, public backstop is a measure that would be very useful but certainly should be agreed with the Commission according to the existing rules.
Ah “public backstop” words which should send a shiver down the spine of Euro area taxpayers who seem to be facing more socialisation of banking losses. We also got quite a contradiction to the past official mantra that there is no real problem.
The second point about the NPLs in Italy: I think the very first measure – well, certainly, it’s a big problem
He even pointed out the transmission mechanism to the real economy.
But we should be aware that the longer we have this in place, the less functioning will be the banking system, or at least will be the banks with high NPLs, and so the less capable will be these banks to transmit our monetary policy impulses to the real economy.
Then we got a clear hint to future policy.
One of the measures is to have a well functioning market for NPLs. What is needed for such a market to develop?
The problem is that it is quit easy to see sellers on Italian NPLs but who would buy them? Yes what are called “vulture funds” might but that will not be at a price which is likely to be acceptable to the Italian banks who would have to take a large hit. This is in fact a hint that the ECB will be the buyer as the discussion is very similar to the way the ECB wanted an ABS market to develop so that it could start buying them! He also gave a clear hint to the Italian government.
Several things, but one is in my view dominant, namely to create a legislative framework where the NPLs can be traded and sold easily.
Build it and we will come is the message here.
The Market response
This was covered by the Financial Times
European bank stocks, led by Italian lenders, rallied……The rally in Italian bank stocks was led by a gain of 4.1 per cent for the shares of Banco Popolare. Shares in UniCredit, Italy’s largest bank, were 2.4 per cent higher. Monte dei Paschi shares rose 1.6 per cent.
Actually that did not seem much of a response frankly. After all the share prices of these banks has fallen so much that these were very minor responses. Also we were told this.
The remarks by the president of the European Central Bank, at his monthly press conference, helped alleviate concerns about Italian lenders,
I am not sure that is right as maybe he alleviated the concerns of Italian bankers but he certainly did not alleviate the concerns of Euro area taxpayers.
This is the issue which will not go away. In essence it started with the persistent slow economic growth in Italy which of course then slumped. In other countries there has been economic growth periods which have helped reduce problem loans and strengthen bank balance sheets. But in Italy the banks and the economy have dragged each other downwards. So we see that according to Morgan Stanley Unicredit has an NPL ratio of over 15% and Banco di Monte Paschi dei Siena has one over 35%.
Whilst the Italian state might like to have a bailout there are two main problems. Firstly it has a national debt to GDP ratio approaching 133% according to the IMF. Secondly it has only recently signed up to Euro area bailout rules which mean there has to be a bail in equivalent to 8% of total liabilities before public capital can be used. That is awkward once you realise this. From Bruegel.
The prospect of bank resolution in Italy is complicated by the fact that a large share of banks’ bonds is held by retail investors who – as evident in the previous cases of resolution in 2015 – often had little awareness of the actual risk they were signing up to.
In Italy about a third of bank bonds are held by household retail investors
A bail in would include the Italian equivalent of Mrs Watanabe and would impact directly in the economy. There could be miss-selling compensation like we have seen in the UK but how could the Italian banks afford it? So that would likely have to come from the taxpayer. The Alan Parsons Project covered this.
I just can’t seem to get it right
Damned if I do
I’m damned if I don’t
A bailout via the ECB seems much more likely and for its President it would have the beneficial effect of covering up past misdeeds. Also should he start running out of other countries bonds to buy it seems that there is likely to be a ready supply from Italy. Meanwhile though those who were painfully bailed in vis the Cypriot banks might reasonably think that they were not treated either fairly or equally.