On Jan. 30, Bank of Italy Governor Ignazio Visco called for a review of European Union regulations that require investors take losses before a state can assist a bank – in other words, that a “bail-in” must precede a bailout. His statement came a mere three days after yearlong negotiations between Italy and the European Commission finally yielded a deal designed to help Italy offload bad debt from banks’ balance sheets. The statement also came the day after German Chancellor Angela Merkel and Italian Prime Minister Matteo Renzi met in Germany and appeared, at least publicly, to have resolved relations that had become increasingly sour. Public events aside, Germany and Italy simply have fundamentally different interests that a meeting and handshake between Merkel and Renzi cannot overcome.
As we have discussed in recent weeks, Italy has a serious problem with non-performing loans, which amount to roughly 17 percent of Italy’s GDP. The European Union has finally realized that the problem is serious enough to warrant collaborating with the Italians on a solution. The EU does not like the term “bad bank,” so it has made sure the vehicles that will be used to package Italian debt will not be called “bad banks.” The principle however is much the same – Italian non-performing loans (NPLs) will be packaged into securities and moved to separate entities to reduce the amount of bad debt Italian banks hold. Italian banks can choose to purchase state guarantees at market prices on the least risky tranches of bad debt.
Publicly, Italian officials are touting the deal. On Jan. 31, Alessandro Rivera, director-general for the banking and financial system at the Italian Finance Ministry, told the Financial Times that investors are “extremely interested” in participating in the plan. But the market for asset-backed securities is already weak throughout Europe, and Italy has thus far been unwilling to clarify how much risky debt will be packaged into the tranches being sold, and what percentage of the 350 billion euros ($381 billion) worth of bad debt it expects the new scheme to address.
An example of the problem is seen in the difference between northern and southern Italy. Italy really exists in two fundamentally different economic realities. Italian Professor Stelio Mangiameli of the University of Teramo estimated in 2012 that northern Italy accounts for more than half of Italy’s GDP, despite the fact that less than half of the Italian population lives there. Unemployment in Italy is roughly 12 percent according to Eurostat – yet in southern Italy unemployment is over 20 percent.
This divide is reflected in NPLs as well. In absolute terms, northern Italy is responsible for more than half of non-performing debt according to Italy24. But banks in northern provinces hold a much lower percentage of NPLs in their banks. NPLs account for around 7 percent of all debt held by banks in provinces like Bolzano, Trieste and Sondrio. In southern provinces such as Reggio Calabria and Trapani, that figure is more than 30 percent. The idea that investors will be “extremely interested” in taking on “non-risky” debt from southern Italian banks without knowing the exact composition of the tranches being offered seems overly optimistic. This is the fundamental problem. The banks that most need NPLs taken off their balance sheets are the banks with the least valuable securities to offer.
The European Commission and Italy’s plan to offload bad debt with the assistance of state guarantees was a positive step, but Italy knows that it is not a comprehensive solution. Having secured the cooperation of the Commission, Renzi went to Germany to barter with Merkel over Italy’s debt burden, which, at 132 percent of GDP, is the second largest in Europe after Greece. Merkel wanted Renzi to stop blocking 3 billion euros of EU aid from going to Turkey to help Ankara deal with the influx of millions of refugees of the Syrian civil war. Renzi wants the European Commission to go easy on Italy as it embarks on a review of Italian state finances – a response to the EU expressing concerns that Italy’s 2016 budget contained deficit projections exceeding levels acceptable to Brussels. It appeared on Jan. 29 that both sides would get what they wanted. Renzi has already dropped Italy’s objections to the aid for Turkey and pledged that Rome would pay its share. For her part, Merkel said that she would stay out of the European Commission proceedings, but it remains to be seen whether Brussels will be flexible in its review.
The European Union and Germany have given Italy an inch – and now Italy is looking to take a mile. Though Italy is the country in a precarious financial situation, it is also the third largest economy in the eurozone and the eighth largest economy in the world. Italy knows that Germany cannot afford for the situation to get out of hand, and that a repeat of Cyprus or Greece in Italy would have dire consequences for both the European and global economies.
This is the context in which Bank of Italy Governor Ignazio Visco called for the review of the new European bail-in laws. Italians are already understandably nervous about the laws’ potential impact in light of the fact that before the regulations even came into effect, Italy both bailed out and bailed in four small Italian banks. It was a bailout in the sense that Italy created a 3.6 billion euro National Resolution Fund with money from Italy’s healthy banks to rescue the bad ones – but it was a bail-in because shareholders and bondholders lost approximately 790 million euros in the deal. If more Italian banks succumb to their debt issues, shareholders, bondholders and depositors holding more than 100,000 euros would be on the hook for an unknown yet substantial portion of the cost before recourse to public money is possible.
Italy then is in somewhat of a catch-22. It needs to generate investor interest in the securitization of non-performing debt held by Italian banks, so it must tout its recent agreement with the European Union. It also needs Germany to relax its insistence on austerity and to give Italy the flexibility and support it needs to tackle its problems. But what the European Union and Germany have offered so far amount to, at best, a Band-Aid on Italy’s NPL problem. And so the governor of the Bank of Italy says bail-in regulations must be reviewed at the same time that a senior official in the Italian Ministry of Finance says securitized Italian debt is a tremendous investment opportunity. On the outside these are contradictory statements. But Italy is in a contradictory situation. Both are simply fighting to preserve Italy’s interests.