Download Italian Bank Crisis and the Effects on the Eurozone

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ITALIAN BANK CRISIS AND ITS EFFECTS ON THE EUROZONE
Gianluca Manzillo
Pitzer College
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ITALIAN BANK CRISIS AND ITS EFFECTS ON THE EUROZONE
Abstract
In recent times Italy has been facing a deep bank crisis due to the presence of nonperforming loans which affect in negative way the balance sheets of some of the most
important Italian banks. Considering that Italy is very important for Europe’s economy,
a collapse of its financial system would lead negative effects to the whole continent.
In order to face its problems, Italy asked the European Commission for different plans
to be adopted, and one of these was the creation of a “bad bank”.
According to the diverging expectations, Italy and Germany are going in direct contrast,
with Italy trying to get the most suitable helps for its situation and Germany that is not
so willing to hold these responsibilities.
From this crisis arise not only economic problems, but also political ones, due to the
missing objectives that should have been reached and the barely reaction of the who
manages the concerning system, defining the disappointment of the European citizens
as well.
Italy is trying to escape from this current bad situation, and for the moment, the only
thing it got is the imposition of restrict financial targets for 2016 from Brussels. In this
paper I am going to show how it was possible to get to this situation, and, from the
current situation, to display the effects derived from that, trying to give as the widest as
possible a general outline of the Italian situation and also the other effects that were
forecasted from that. All that explained through the news that were spread during these
last times and through the exploitation of data deriving European Central Bank.
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INTRODUCTION
These are days of great tension in European markets: prices of collapsing actions, in
addition to the difficulties of bank bond markets to price the bail-in, saving inside of the
bank with the partial imposition of losses on creditors and bondholders. Italian banks in
particular are under fire by investors. Monte dei Paschi has lost more than half of its
value since the beginning of year and hovers so much uncertainty that many
commentators rely on the black hand of international speculation. A more plausible
truth is that Italy is facing a combination of external factors, such as the bail-in, and the
interior, with the failures of the government and supervisory institutions accumulated
over time.
The issue of non-performing loans of Italian banks is not new. It was talked about it
already in 2009, with the first crisis of Monte dei Paschi di Siena, and then in 2011,
when Italy faced sales on government bonds guided by political and economic
uncertainty. In early 2012, neither the 1% of liquidity from ECB obtained by Italian
banks was able to spur the government in defining a saving plan in the case of a
possible bank crisis. In mid-2012, the European Commission proposes new rules on the
resolution of banks’ problems, including the new bail-in, where Italy signed with no
constraint on the creation of common financial protection of the banking union, in other
words, the European fiscal backstop.
Neither the Spanish banking crisis, very similar to our own, spurred Italy to join forces
with other countries, like France, for the direct recapitalization of the European Stability
Mechanism(ESM). Spain was left alone and it was able to get ESM fund just through a
process of accounting of public debt with the obligation to undertake fiscal reforms with
Troika. The indirect recapitalization is justified when a union bank is absent. After the
Cyprus crisis of March 2013, also settled with indirect recapitalization, the situation on
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international markets improved and it all ended in oblivion. In September 2013, it was
approved the Single Supervisory Mechanism (which is a mechanism which granted the
European Central Bank a supervisory role to monitor the financial stability of banks
based in participating states) and it was launched a review of the financial statements of
the all Eurozone banks. The Italian banks functioning showed evaluations of the very
“optimistic” non-performing loans than the other European banks and so, the ECB
obliged them to recapitalize. The Government undertook other bailouts. Then there was
the revaluation of the Banca d’Italia shares, which transferred to the banks a capital gain
of more than €5 billion, in violation of an EU directive requiring the passage of the
Bankitalia to the State.
In December 2014, the 18 finance ministers of the euro area guiding the ESM approved
the Direct Recapitalization Mechanism. What comes out from the ESM is very
disappointing compared to what is called for in 2012. It should have provided a ceiling
of €60 billion for the entire fund, while only with the Spanish Indirect Recapitalization
were blocked €100 billion. The fund could only intervene for large financial institutions
and only if direct state intervention could damage the fiscal sustainability. The
procedure, however, has not been formally activated and the result would have been an
Indirect Recapitalization the same, considering insufficient the resources of the bail-in
and of the resolution fund, even if with a government loan.
The result of this management of European policies is that today Italy is located on a
corner by itself mistakes (and without a plan B), asking the Commission to approve a
bad bank (that was refused) and for a new plan to be applied.
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KNOWING BETTER THE ITALIAN SITUATION
Everyone is giving attention to Italy’s situation, because, through its political way of
functioning, there could be the serious possibility to derail the European project for real.
If Italy continues on its current bad trajectory, it will drag the whole structure down.
Basically, the main problem of Italy is its stagnant level of GDP which can be related to
the concept of “Japanification” of the economy, which is basically correlated to the
concept of deflation experienced by Japan that should bring to a decrease of
expenditures concomitantly to the fall in prices of the services rendered, but it has never
happened, and Japan was blocked in a situation of revenue/national GDP deflation.
In these recent times, Italy is experiencing the same situation, facing the problems
related to keeping up with the current public expenditure, or\
in other words, the government consumption. The investments, that could be easily be
lowered today without any difficulties, reached a very high level, and by having revenue
flat lines and the current expenditures keep rising, the shortfall comes because of the
huge level of debt contracted. And now, the difference between the future prospects and
flat lining revenues is really hard to be fixed without undertaking sacrifices which will
lead no payout in the following years.
So, as the Japan, Italy is locked in a situation of stagnant nominal GDP against growing
debt due to the current expenditures which are sustained by law and enforced by an
ageing population with a feeling of entitlement.
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Looking at this chart, it is easy to understand that one day in the future, there will be the
unavoidable need to face this current unsustainable trajectory.
There should be the need to spur the households to fund state consumption giving them
a sense of investing their money for the future. In other words, household should save
their money in banks or in public pension funds in order to provide enough resources to
sustain their own future retirements. But, through this reasoning, it is possible to
understand the vicious circle related to this: there are no savings, they are basically
registered on the balance sheets, but, as a matter of fact, they are removed from what
can be considered as real productive investments.
Considering this way of moving of GDP, it is possible to say that banks’ assets
availability moves the same way. Actually, both GDP and banks’ assets are interlinked
each other, and as far banks do not find someone willing or able to borrow money and
undertake investments, they are forced to scale back. So, the nominal GDP continues to
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expand, while the need of public expenditure continues to keep the public debt rising
constantly.
If there are no borrowers, a situation where banks push credits to who needs them is
pretty impossible, but the need to run a positive nominal GDP is so deep that overcomes
the common sense. In this sense it is possible to understand that the sectors with loan
growth are exactly the unproductive sectors that should deleverage and free up
resources for the productive sectors.
So, through this, it is easy to understand that the Italian investments are falling down
respect to its peers. Italian banks are officially swamped with €200 billion worth of nonperforming loans.
Now, according to the current situation, the main objective is to clean bad debts from
banks’ balance sheets in order to let them start to lend again money.
The Italian government has presented a plan which is not so suited for the markets
because they are constrained by the EU regulation which tries to make possible to attain
something that could benefit Italian banks. And now a new bail-out comes, forcing bailin of debt holders and unsecured depositors before any state aid can be provided to
banks.
But, there is the need to take in consideration that the typical Italian and European
bureaucrats approach is a sort of extend-and-pretend option as long as it is available for
them, and there will be a reaction only when it is so clear that it will be really hard for
them to recover from the situation created by themselves. In other words, a real change
comes only when there is the need to define an ultimate monetary end-game.
While the monetarization of bad assets can be considered as the way out for Italy
because in this way the banks can expand again their balance sheets, let the nominal
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GDP growth and keep under control the ratio between debt contracted and GDP; there
is the need to take in consideration that Italy can be seen as a train going to crush in
slow motion, this is because its consumption overcomes the production, the capital base
is being eroded, the labor capital is declining and the living standards are stagnant; the
only thing that keeps this thing running is its ability to roll-over and issue debt.
ALTERNATIVE SOLUTIONS TO FIX ITALIAN BANK CRISIS
In order to enhance the Italian economy by speeding up disposals of non-performing
loans and making available more resources for credit to companies and households, the
Italian Prime Minister Matteo Renzi has been trying to get the approval by the European
Commission for a bad bank.
The bad bank asked to be set up consists in a bank which buys the bad loans of a bank
with significant non-performing assets at market price. In this way the institutions can
transfer their bad assets to this bad bank in order to clear their balance sheets, but in
doing that they are forced to have write-downs. In this way bondholders and
shareholders lose money, but not depositors. And, banks that become insolvent because
of this process can recapitalize.
In other words, through a “bad bank” it is possible to absorb these loans, so that the rest
of the system can be restored to health and serve its essential purpose of lending in
support of economic growth.
The main problem regarding the functioning of this bad bank is how to allocate the
losses across the system’s various stakeholders. There should be the need of more
flexibility from both sides (stakeholders and institutions) in order to offset the current
gap. Basically, Italy has the characteristics of a good-working business system and
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excellent long-term prospects, but it is affected by a not-so-stable financial system
which risks to compromise its growth over time.
But, this solution proposed by Italy was rejected by the European Commission. So, after
that, Italy proposed another plan, it is the so-called Garanzia sulla Cartolarizzazione
delle Sofferenze (GASC), the idea concerning the GASC is to provide government
guarantee that should provide coverage that allows the gap between the net book value
and the market value of the non-performing loans to be adjusted. In this way, demand
and supply of non-performing loans should be able to intersect, and should give banks
the opportunity to dispose of many of the impaired assets that are choking their balance
sheets, without having to account for further significant credit losses that have no
benefits if not in terms of lower taxes.
The structure of the GASC is the following: there will not be a single bad bank, but
many, and each of these banks has the possibility to activate the state guarantee ondemand. But these guarantees will cover only the risks of the senior tranche, meaning
that the State guarantee will become effective only when the losses on the pool of nonperforming loans that comprise the assets of the bad bank will have already completely
eroded the subordinated tranches.
But, this solution presents a number of unknowns related to the placement of the
subordinated tranches and to the fairness of the price paid by the banks for the state
guarantee. These unknowns could jeopardize the effective ability of the State guarantee
to achieve its goals.
Either these Italian plans are attempts to shift the risk from the banks to the Italian
government (which is precisely what new EU regulations try to prevent). The EU wants
Italian debt holders and depositors to be the first line of defense, not public funds.
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There could be also a possible alternative to GASC that consists in a securitization
scheme based on the banks’ gradual disposal of a suitable mix of good and bad loans.
According to this possible solution, the cash-flows produced by the performing loans
would support the payment of the coupons on the asset-backed notes, so, in this way,
the bank would be more financially sound.
This alternative way is good for Italian banks in order to offload their non-performing
loans and clean their balance sheets making possible to restart to provide credit to the
economy; and it would be also useful to reduce risk exposure and keep it under control.
Actually, the last thing Europe needs is the worsening of the crisis of one of the biggest
economies, and in order to face that, European and Italy are trying to find a compromise
in order to define the most suitable bank reform.
So, beyond the request from Italy for a bad bank and another new plan, there is also the
setting by the European Commission of the so-called Single Resolution Board (SRB),
which is part of the wider Single Resolution Mechanism (SRM), it is the resolution
authority for the significant and cross border banking groups established within
participating Member States. Its mission is to ensure an orderly resolution of failing
banks with minimum impact on the real economy and on public finances of the
participating Member States and beyond.
The Single Resolution Mechanism which generates the Single Resolution Board, will
strengthen the resilience of the financial system and help avoid future crises by
providing for the timely and effective resolutions of cross-border and domestic banks.
There are several benefits deriving from the Single Resolution Mechanism: more
uniform financing conditions for individuals and businesses, creating a situation where
it is possible to deal with the failure of banks of the European Union by reducing the
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interdependence between credit supply and the health of public finances; better
preservation of financial stability, creating a more predictable environment of
consumption and investment decision, and this will be reached through a centralized
management of crises for large and cross-border banks which their failure could
otherwise spread a contagion across the whole continent; a reinforced protection of the
taxpayers through the application of the bail-in tool and of a Single Resolution Fund (if
it is necessary) going to gather resources in order let function crisis management in the
best way.
Instead, the Single Resolution Board will decide when a bank has failed and when it
should be put into “resolution”, which consists in a special system of rules to prevent a
failure from spreading panic across the financial system. In other words, it has the
power to decide which steps should be taken to ensure a safe wind-down.
In this way, regulators will have more force in forcing senior creditors and largest
depositors to take losses before the public money is used.
FORECASTING THE FUTURE
An Italian bank crisis could trigger a financial disaster for whole Europe, forcing it to
adopt a very massive bailout.
The effects of market turmoil and the previous dangerous solutions being set by EU
authorities in sudden response to that turmoil, could define more latent financial
vulnerabilities in fragile EU members.
Italy is the Eurozone’s third-largest economy, and the eighth largest in the world. Its
economy is over seven times the size of Greece’s. An economic collapse in Italy would
put Europe in a crisis far worse than the Greece’s one
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Even if the crisis calms down again, the non-performing loans remain a major problem.
A financial crisis triggered elsewhere could easily push Italy over the edge, and after
that, it could drag the whole Europe with itself.
With the end of Schengen and the reduction Eurozone, the negative effects deriving
from the current situation could be accompanied by the threat of growing income
inequality, the disappearance of the middle class and the subsequent radicalization of
politics.
With this is not necessarily to say that democracy is in danger, but certainly the
agreements and institutions that go beyond national borders do. These are certainly not
ideal conditions for European integration, coordination and international cooperation.
The banking problems are increasing the risk of a political divide in Europe. The new
bailout rules are Germany designed, they force countries to raid money from their own
business and savers before they come asking for money from German taxpayers.
Obviously, this is a pretty good situation for Germany, while for Italy it is not.
The Eurozone economic crisis has evolved into a political crisis where a growing
number of voters oppose the European Union and the political elites who manage it.
Moreover, the Italian bank crisis, risks to worsen the current Europe situation which is
struggling to the current migrant crisis.
An economic crisis together with the ongoing migrant crisis would tax the whole
Europe to the extreme, creating a situation of pressure without knowing if there will be
an efficient and effective solution.
The ongoing reality is bringing Italy in direct contrast to European Union, and
especially to Germany, the deficit projections for Italy’s 2016 budget exceeded the
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previous target, and the EU is planning to review Italy’s budget targets, so, Brussels is
trying to impose financial targets on Italy.
Italy wants to get help from European Union in this particular moment of difficulties,
but Germany does not want to held the responsibility for another nation asking for
support.
The forecasting of how the current Italian bank crisis could evolve states that 2016’s
problem will become very serious if there will not be a creative intervention by the
other European countries. The current results do not provide positive perspectives, and
if it will continue on this way, it could be possible to have a crisis with the same
characteristics of the Greece’s one, but with wider and worse effects.
Though markets have pared losses in the last few weeks, March has brought renewed
concern for the health of Italy’s financial sector. Moreover, the European Central Bank
has demanded that another troubled Italian bank, Banca Carige Spa, must provide new
strategic plans and additional funding in order to strengthen its balance sheet and meet
supervisory requirements.
But currently, authorities assure the public that the banks are well capitalized and,
though it may take some time, solutions will be realized. Italian Prime Minister Renzi
states that “The situation is much less serious than the market thinks.”