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1 ITALIAN BANK CRISIS AND ITS EFFECTS ON THE EUROZONE Gianluca Manzillo Pitzer College 2 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. 3 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 4 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. 5 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. 6 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 7 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 8 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 9 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. 10 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 11 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 12 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 13 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.”