The Italian Job…?

With apologies to film fans (we prefer the original 1969 version) , we thought we would consider the conundrum presented by the state of the Italian banking system, which has become “collateral damage” post-Brexit.

The basic problem is that, in an economy that barely manages any real economic growth; where the level of government borrowing can crowd out private investment; and where there are many obstacles to restructuring loans and businesses in default, the banking system is choking on a very high level of non-performing loans (NPLs), which makes it very difficult to focus on supporting promising and profitable businesses with new funding.

Compounding the problem is the tension between the supposed constraints of the EU’s new Bank Resolution and Recovery Directive (BRRD), which is intended to remove the need for taxpayer-funded bank rescues by “bailing-in” bank creditors in a pre-determined sequence, and the fact that Italian banks have an unusually high level of such “bail-inable” debt owned by individuals, rather than institutions. When the Bank of Portugal re-ordered Novo Banco’s obligations to “haircut” foreign bondholders, the result was a legal dispute and questions about Portugal’s “reliability”. However, domestic politics were largely unaffected. The situation in Italy is very different. The government and the Banca d’Italia are rightly concerned that, with an important constitutional referendum due in the autumn, any action against an Italian bank that caused losses to individual debt holders would cause a political firestorm, with potentially adverse consequences for the continuing attempts to restructure a sclerotic economic and political system.

A further issue is that the European Banking Authority is due to release the results of its latest stress-tests of the largest European banks on July 29th (during the mid-year reporting season for publicly-quoted institutions and just before the business and political elites go on holiday in August). The outcomes of previous exercises proved somewhat controversial, widely regarded as giving many institutions a “false positive” and thus understating the weakness of a number of banking systems, including Italy’s. With that in mind, one would hope that this year’s outcome will be somewhat more rigorous. However, if it is, the concern has to be that a number of Italian banks will be found wanting and in evident need of restructuring and recapitalization.

There is just one small problem with that. EU state aid rules now make it difficult for a government to be seen to supporting an entity on anything other than arm’s length commercial terms. In Italy, we have already seen the political “fudge” that is the Atlante mechanism for back-stopping capital-raising by banks- and its resources are now almost exhausted. The Italian government has threatened to use what amounts to an “exigent circumstances” exception to re-capitalize its banking system directly; but that has drawn the ire of both the European Commission and the German Federal Government. The ECB stirred the pot by suggesting a “bad bank” approach; but that in itself pre-supposes the strict resolution of a failing bank, which will likely exacerbate the political problems alluded to above.

The root cause that needs to be addressed urgently is the lack of a mechanism for clearing the system of its overhang of NPLs. This is an area in which Awbury, with its expertise in melding techniques from insurance, banking and the capital markets stands ready to help, as we have long been studying and researching ways in which we can help our clients manage and work through their existing NPL and bad debt portfolios.

So, rather than being bemused and baffled by the Italian Job, call us- and come enjoy “A Room with a View”, and a return to “La Dolce Vita”…

The Awbury Team

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