The European Commission and Italy on Jan. 26 reached an agreement on a plan to allow Italian banks to offload bad debt with the assistance of state guarantees. Nevertheless, the agreement will not resolve Italy’s banking woes. The acceleration of negotiations over the past weeks indicates that the EU has come to recognize that Italy’s banking troubles are reaching a crisis point and could impact economies across the eurozone. The agreement, however, is modest and limited in scope. The full technical details are not yet available, and it remains unclear whether the plan will succeed in incentivizing investors and banks to participate. What is clear is that the agreement, even if implemented, will not constitute a comprehensive solution for Italy, as the country will continue to struggle to address its banking challenges while adhering to EU rules.

The scheme agreed to yesterday by Italian Finance Minister Pier Carlo Padoan and European Union Competition Commissioner Margrethe Vestager allows Italian non-performing loans (NPLs) to be securitized and moved to separate entities, with the aim of reducing the amount of bad debt on Italian banks’ balance sheets. Italy will then offer state guarantees, at market prices, but not for all bad debts. State guarantees could only be applied to senior tranches of bad debt – that is, the most highly rated and least risky tranches of bad debt. Senior tranches have first call on the income generated by the underlying assets. The exact pricing of the guarantees will be calculated based on risk, and will increase over time. The European Commission has agreed that because state guarantees will be priced at market rates, they will not amount to state aid under EU rules. As a result, banks will not receive discounts or any other extra incentives.

Negotiations between the European Commission and Italy over how to address Italy’s large stock of NPLs had been stalled for months, despite the risk that high levels of bad debt present to the stability of Italy’s banking system. Over the past few months, two events provided impetus for the European Commission to finally come to regard Italy’s banking challenges as a potential serious crisis. The first was the bailout of four small banks in November, which led to significant public outrage in Italy, particularly following the suicide of a pensioner who lost his life savings as a result of the deal. The second event was the drop in the value of banking shares in Italy in January, as fear spread after the European Central Bank requested information on Italian banks as part of its review of NPLs held by European banks.

One of the chief weaknesses of the European Union is its inability to address crises until they are already unfolding and the effects of this can be seen in the ongoing European economic crisis. In our forecast for 2016, we predicted that the focus of this crisis will shift to Italy this year. Yesterday’s deal may calm some fears in the markets over the state of Italian banks, but it will not on its own resolve Italy’s banking woes. State guarantees will only be provided for senior tranches of bad debt, and the EU requirement of offering these guarantees at market prices means decision-makers in Rome cannot offer extra incentives for participation in the scheme. At the same time, new EU-mandated rules that impose losses upon shareholders and large depositors before the Italian government can use public money to aid banks are contributing to uncertainty over the future stability of Italy’s banks.

Ultimately, much of the outcome of the deal will depend on technical details, but above all, what yesterday’s agreement demonstrates is that the EU is now beginning to regard Italian banks as a significant threat to eurozone stability. Nevertheless, the agreement is not a comprehensive solution. The deal allows the Italian state to partially bear the burden of the banks’ problems, but still blocks it from making a significant intervention in the sector. This means that Italy will continue to struggle to stabilize its banking sector, while the EU grapples with the challenge of both adhering to its own rules and preventing contagion from a potential crisis in Italy. Italy’s banking problems are unfolding, but comprehensive solutions are slow to arrive.