Germany could not help out Italy and its lenders should the country suffer a similar fate to that of Greece. 

Italy’s debt-to-gross domestic product (GDP) ratio is 132% – more than twice the level set down by the Maastricht Treaty for euro convergence. Italian non-performing loans (NPLs) amount to €360bn, which is 18% of total loans and equal to one-sixth of Italian GDP. This means that the hard-pressed Italian government would struggle to rescue its banks even if it was allowed to do so under the eurozone’s new Single Resolution Board. 

For some time now analysts have worried about a butterfly effect whereby problems in an Italian bank could set off a chain reaction across the European banking system. 

The creation of a €5bn backstop fund to bail-out Italy’s weaker lenders if necessary, as reported in the Financial Times, may go some way to assuage these concerns. But it still leaves Italy with one of the weakest banking systems in Europe. 

The Italian government has also promised to sort out the country’s anachronistic bankruptcy laws whereby recoveries average seven years (against a European average of two or three years) and can take as long as 12 or 13 years. New legislation has been promised within the next 10 days (i.e. by April 22).

Even if this happens there is still a long road ahead. Seventy per cent of Italian NPLs relate to small and medium-sized enterprises, are of old vintage and collateral quality is mixed, according to ratings agency Fitch. A state-guaranteed NPL securitisation scheme was launched in February as an alternative to outright sales but, says Fitch, “banks have said the scheme looks overly onerous and this is likely to reduce their willingness to participate”.  

The action on the bail-out fund was triggered by a planned capital raising by regional bank Popolare di Vicenza to be underwritten by the country’s largest bank and one of its strongest, UniCredit. If the shares went unsold and ended up on UniCredit’s books it might have led UniCredit to need more capital itself and so made the problems of one bank a problem for the sector as a whole. 

As it is, the bail-out fund involves larger, stronger banks supporting smaller, weaker banks, and whether this contains or spreads the problem is still to be discovered. 

In a common currency system such as the euro, Italy’s poor finances and weak banking sector present a huge challenge. We have seen with Greece how the economic difficulties of one member can impact on other members, and how solutions have to take account of both economic and political realities – in short, how much German taxpayers are prepared to spend helping out a country in trouble. 

There has been a huge furore over Greece, an economy 18 times smaller than Germany’s. Italy’s economy, by contrast, is more than half as large as Germany’s. If Italy gets into difficulties, the eurozone is in such trouble that whether the UK stays in or out of the EU will be of no consequence whatsoever.

Brian Caplen is the editor of The Banker.

Order The Banker July edition

FREE trial access to Top 1000 World Banks

Join our community

Highlights - Bank of the Year Awards 2017

Silvia Pavoni, economics editor and Brian Caplen, editor of The Banker, discuss the winners and highlights from this years awards ceremony.

The Banker on Twitter

By continuing to use this site you consent to the use of cookies on your device as described in our cookie policy unless you have disabled them. You can change your cookie settings at any time but parts of our site will not function correctly without them.