Crisis on the Italian banking market and the consequences for Europe

Since the Brexit decision, the Italian banking sector has come under enormous pressure once again. In particular the share prices of domestic banks have recorded palpable losses, but risk premiums on bank bonds have also widened. However, multiple reports of the great efforts being undertaken by the Italian government to inject state aid into the domestic banking sector have caused some of the spreads to narrow again.

The Italian government’s first request for a bail-in (i.e. capital aid without forcing bond creditors to participate in losses) was rejected by the EU Commission with the expected reference to the ban on state aid. The Italian government quickly denied any accusations that it would support its crisis-stricken banks with public funds without the approval of the EU Commission. Nor have the other rumours and press reports that the banking market might be salvaged through state or private finance been backed by further details or even confirmation. But a spokeswoman for the EU Commission did confirm that talks with Italy over the use of public funds would continue. A number of possible solutions existed that were in keeping with EU regulations.

The probability of the EU Commission finally consenting to state support in a specific case cannot be ruled out. In the event of a capital increase with state aid, the probability of this happening with at least the junior creditors having to participate in the losses is very high. Whether retail creditors, as suggested by some reports, can be spared any loss participation remains to be seen.

Italy’s case illustrates the unwillingness of governments to apply the regulations of the European Banking Union which also involve the participation of creditors and investors in the losses of banks. The risk of the banking sector being squeezed even more after a potential bail-in appears too great. Rather than progress with the adjustment process, the Italian government prefers to continue the status quo and support banks with state aid. The consequences of such a policy are well known and the Italian banking sector continues to pose a great risk for Italy as well as for the entire Euro area. What makes this development all the more alarming is that the calls for a European deposit protection scheme also involve the risks being spread out over all countries. This would be almost tantamount to fiscal union. Yet the democratic legitimation for this process would not exist which, in turn, would damage the credibility of the EU.


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