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Italy: Preparing to Weather the Financial Storm
Teaser:
Italy is about to feel the effects of the global financial crisis, largely because of its exposure to
Central European and Balkan banking markets.
Summary:
The board of Italy's largest bank will meet Oct. 28 to discuss the global financial crisis. Italy is
about to feel the effects of the crisis, largely because it is exposed to the banking markets in
Central Europe and the Balkans, which are set to feel the most pain from the credit crunch. A
crisis in Italy could spread throughout Europe.
The board of Intesa Sanpaolo SpA, Italy's largest bank, will meet Oct. 28 to deliberate over the
<link
url="http://www.stratfor.com/analysis/20081027_financial_crisis_carry_trade_and_global_syste
m">global financial crisis</link> that is sweeping across Europe and review the bank's three
year business plan. This meeting cannot happen soon enough for the nervous investors feeling
pressure to sell the significant stakes they hold in a number of major Italian banks (Intesa
competitor UniCredit's stock is at an 11-year low). Perhaps the most worrying aspect of such a
run is that Italy in general, and Intesa and UniCredit in particular, has considerable exposure to
the banking markets in Central Europe and the Balkans, which are due to face the most painful
squeeze amid the financial turmoil.
Italy is one of the world's core economies, with a gross domestic product (GDP) of more than
US$2.1 trillion. It is the fourth largest economy in Europe and seventh in the world; with one of
Europe's wealthiest and most influential financial regions centered on the historical banking hub
of Milan. (It really is the wealthiest region of Europe… I know it is crazy, right after London) A
serious problem in the Italian banking system is therefore a dire signal to the rest of Europe. Any
problem in Italy would reverberate in entire Europe, potentially cascading into a serious
eurozone conflagration that could spell doom for the euro and the monetary union.
Italy's problems are twofold. The first problem is the Italian banking sector's exposure to
emerging Europe (Central Europe and the Balkans); the second is that Italy has poor economic
fundamentals.
Milan-based banking giants Intesa and UniCredit's exposure to troubled Central Europe and the
Balkans could precipitate a collapse of the entire Italian banking system. This is true particularly
because Intesa and UniCredit are greater than the rest of Italy's banks combined. Their combined
market capitalization stands at more than 80 billion euros (US$100 billion), and their combined
total assets equal more than 50 percent of Italy's total GDP. Intesa and UniCredit rushed into
emerging Europe because the region presented virgin markets that were profitable expansion
opportunities for the Italian banks with little or no competition from their usual competitors -the powerful U.K., Swiss and German banks.
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One of the favored strategies of <link
url="http://www.stratfor.com/analysis/20081015_hungary_hints_wider_european_crisis">foreig
n banks for expansion into Central Europe and the Balkans</link> has thus far been foreign
currency lending. Much as the <link
url="http://www.stratfor.com/analysis/20081020_hungary_hungarian_financial_crisis_impact_a
ustrian_banks">Austrians did with Swiss franc lending</link>, Italians rushed to provide firsttime consumers in Central Europe with cheap foreign currency-based loans. Italian banks were
able to offer mortgages and personal/business loans with interest rates of sometimes up to 5
percent lower than the domestic currency loans because the loans were denominated in either
Swiss francs or euros. The customer was therefore saving costs on the interest rate, but was
exposed to the risk of unexpected monthly payment changes due to currency fluctuations. This
has become an enormous problem as the <link
url="http://www.stratfor.com/analysis/20081022_hungary_panic_rate_hike_and_potential_conta
gion_effect">Hungarian forint</link>, Romanian leu and other currencies of the region have
depreciated due to the global crisis, but particularly because of how the <link
url="http://www.stratfor.com/analysis/20081012_financial_crisis_europe">crisis is playing out
in Europe</link>. As these currencies fall, the original value of the loan -- denominated in euros
or francs -- becomes more difficult to service.
The problem is quite extreme for Austrian and <link
url="http://www.stratfor.com/analysis/20081020_bulgaria_signs_global_liquidity_crisis">Greek
banks</link> -- as well as Swedish banks in the Baltics (LINK:
http://www.stratfor.com/analysis/20081020_sweden_safeguards_against_banks_exposure_baltic
s) -- that are immensely exposed to the region and do not have the capital base of the Italian
majors to back the exposure up. Austrian banks Raiffeisen and Erste Bank are particularly
vested, but Italy's UniCredit also has nearly $130 billion in assets in the region (more than any
other bank), and Intesa has nearly $50 billion. If depreciating currencies in the region cause loans
made in foreign currencies to appreciate and customers to begin defaulting, Italian banks could
be in real trouble. Unlike their Austrian and Greek counterparts, the Italian behemoths have more
capital to throw at the problem, but just the mere exposure to the risky Central European markets
has caused investors to begin selling off their stock. Since January, Intesa has lost 38.3 percent of
its stock value; UniCredit has lost 55.4 percent and may have to cut dividends in light of
decreasing profits. On Oct. 24, it was reported that the government might buy a stake of around
10 percent in UniCredit -- a move that could become necessary if losses continue mounting.
Trouble with the two banks will become a Europe-wide problem if the Italian government is
unable to bail them out. Intesa is the fourth-largest bank in Europe and UniCredit is the eighthlargest, and both are highly involved in various Western European banking systems. Banking
collapse in Italy could reverberate throughout the eurozone as investors begin doubting other
Western European banks.
Even if its banks were not so exposed to risky markets, Italy bears the weight of some rather
poor economic fundamentals. It has the world's third-largest public debt -- topping $1 trillion, or
about 55 percent of GDP, which surpasses France's debt and approaches Germany's. The Italian
government is running a 2 percent deficit and expenditures that total almost 50 percent of GDP.
Furthermore, the budget revenues it receives from taxes is one of the highest in the world in
terms of percentages, at 43 percent of GDP.
The government has already increased guarantees on its deposits to 103,000 euros (need
$130,000) and, on Oct. 8, created a stabilization fund that would intervene in bank collapses. The
government has not set a limit to the stabilization fund, indicating that the government either
does not know the size of the problem or believes that it may be larger than it is willing to
announce publicly.
High public debt, a budget deficit and already maxed-out tax spending and collection ultimately
mean that if Italian banks go under due to the combination of global illiquidity and exposure to
Central Europe and the Balkans, the Italian government has very little room to provide any
significant bailout, particularly to the banking giants Intesa and UniCredit. Italy, therefore, could
be the first significant European country to go under (I'd reconsider this wording -- I realize the
other European countries we've written about aren't huge in the grand scheme of things, but since
the Baltics and Central Europe and the Balkans seem to be the economies contributing to
problems in other, larger, economies, I wouldn't consider them "insignificant." And "go under"
seems to be a bit dramatic, unless we think the whole economy is actually going to collapse.
Could we maybe say something like "the first major European economy to be buffeted by the
global financial crisis"? Agreed! I also think we should change “European” to “eurozone” since
that is really what I meant. I agree with your change, but I also think that “buffeted” may not be
strong enough. I see how “going under” can be perceived as strong. My point is that if any euro
economy is going to be seriously troubled by what is going on, it is going to be Italy). Such a
flurry of worrisome financial activity will likely prompt the European Central Bank to intervene,
with the possibility of International Monetary Fund assistance as well. Italy's choice will come
down to sticking it out through the crisis with outside help -- and possibly facing a prolonged
recession -- or reconsidering its role as a eurozone country.