The fallout from Brexit has brought renewed attention to Italy’s ailing banking system. Geopolitical Futures’ 2016 forecast anticipates a crisis in the Italian banking system stemming from the country’s 360 billion euros ($396 billion) in non-performing loans. Brexit sparked severe market volatility on Friday, with shares in major Italian banks dropping more than 20 percent. There is concern that, amid government efforts to find buyers for bad debt, the uncertainty accompanying Brexit will make this task exceedingly difficult if not nearly impossible.
Italian government and Bank of Italy officials met over the weekend to discuss the possibility of injecting up to $44 billion into the banking system. The exact amount and mechanism for delivery are still under discussion. Italian newspaper Il Fatto Quotidiano reported that injection options include government debt issuance, supporting lenders by providing capital or pledging guarantees. Current EU regulations limit the ability of member states to directly aid private banks, although countries may request exemptions in exceptional circumstances where there is systemic risk.
Italy has already taken steps to safeguard its ailing banking system, but Rome’s efforts have had a limited impact. In April, the Italian government set up Atlante, a 4.25 billion euro fund charged with purchasing shares of troubled lenders and buying bad debt in an effort to alleviate concerns over the Italian banking sector. Two months later, roughly half of these funds have already been used to purchase Banca Popolare di Vicenza and Veneto Banca when both banks’ IPOs failed. Italy’s largest bank, UniCredit, lost 55 percent of its value as of June 1 (well before Brexit) and needs an estimated 10 billion euros in additional capital. The bank received 3 billion euros from the initial round of targeted longer-term refinancing operations loans from the European Central Bank. While this may address some issues in the short term, it is not enough to solve the underlying problems.
Today, Italian Prime Minister Matteo Renzi is meeting with his French and German counterparts, President François Hollande and Chancellor Angela Merkel. Throughout its banking crisis, Italy has struggled to execute solutions in line with EU regulations, which often limited the government’s ability to act and address structural problems. The government in Rome sees Brexit as an opportunity to renegotiate banking regulations with Brussels and deal with its banking crisis with potentially more flexible or absent EU regulations.
Expectations are high that during this visit Renzi will ask for the suspension of state aid rules to allow a capital injection into the banking system. The case can be made that Brexit qualifies as an exceptional circumstance of systemic stress that would justify government action without breaking state aid rules. Brexit opened a Pandora’s box that may lead to restructuring the EU. The bloc’s founding members – including Germany and France – have already admitted that the EU will need to respond to popular discontent and bring back some critical decision-making to national governments.