Bank Clean-Up Opportunity Is Italy’s To Waste

Back in purgatory

Cleaning up Italy’s banks is an opportunity ripe for the wasting. The failed referendum on Senate reform on Dec. 4 need not cause a crisis if UniCredit completes its rights issue and fellow lender Banca Monte dei Paschi di Siena (MPS) can be quickly stabilised. Political turmoil and weak growth, though, could push up bad loan levels, and political will to fix them may be lacking.

The collapse of Matteo Renzi’s government comes at a bad time for Italian lenders, which are collectively creaking with 350 billion euros of bad and doubtful loans. There are four challenges that face whoever replaces the outgoing prime minister.

First is to ensure there isn’t a bank run. Fortunately, such a panic looks unlikely and unnecessary. Banks have access to European Central Bank liquidity, and government bond prices, which determine the value of their collateral, have been stable.

Next is the need to fix MPS, which needs 5 billion euros. A plan to raise that through a share sale and debt conversion now looks hard to execute, as potential investors may be deterred by political instability. If private investors shy away, possible solutions would be a government bailout and conversion of MPS’ subordinated debt into equity. The latter is better, since putting in state cash to help bankers would play right into the hands of the anti-establishment 5-Star movement.

The third thing on the new leader’s list is UniCredit. It wants to raise more money than MPS, possibly as much as 13 billion euros. But it is larger, healthier and under less pressure to raise funds quickly. If both MPS and UniCredit can be fixed, then a crisis is unlikely. Banca Popolare di Vicenza and Veneto Banca need more capital, and could need to write down their subordinated debt, but they are small.

Finally, there’s the longer-term problem of banks’ balance-sheet fragility. Bad debts could increase if an already weak economy gets weaker – as it may without a strongly reform-minded prime minister. Banks may struggle to generate earnings to sell the non-performing loans they already have. The large listed banks could need another 21 billion euros, Mediobanca reckons.

Italy could seize this moment to create a single entity to help the banks sell their bad debt, and accelerate bankruptcy reforms. That would mean imposing losses on some local investors. But if Renzi couldn’t do that, it’s unlikely his successor will. A weak government leaves the banks in purgatory – but not quite hell.

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