The Italian banking system remains vulnerable

Following a turbulent first half-year, the situation facing Italian banks has calmed down somewhat, but the problems surrounding Banca Carige have now shifted investor focus back to this sector again. The bank based in Genoa urgently requires fresh capital, but the procurement of funds was in danger of failing. With transfer guarantees having now been accepted from new shares which might not be subscribed, the capital increase scheduled to run until 6 December now appears to be „cut and dried“, but it remains to be seen whether the institution can be further restructured.

Once again, it is above all the high volumes of non-performing loans (NPL) that are responsible for the banks‘ problems and the reason for their capital erosion. The entire Italian banking sector remains burdened by the weight of the poor credit quality. Italian banks continue to show a total of some EUR 300 billions worth of „sofferenze“ – i.e. loans granted to insolvent or similarly poorly-rated debtors – in their accounts. Most of these loans were granted to small and medium-sized companies which have reacted particularly sensitively to Italy’s lengthy bout of economic weakness.

The more benign economic data and improved forecasts are therefore good news for the still ailing banking sector. The high NPL volumes have recently been in decline, with sales alongside somewhat lower capital inflows – especially at the big banks – and writedowns playing a key role here. Many Italian banks are currently implementing extensive reduction and restructuring plans which are increasingly focussing on securitising and selling, or on directly selling, problem loans. UniCredit alone, Italy’s largest and only globally systemically relevant bank, succeeded in selling NPLs to the tune of more than EUR 17 billion in the first half of 2017. This has resulted in a reduction in the share of NPLs in the total credit volume, with a decline of some 15% now being recorded for the entire banking sector.

However, the crisis at Banca Carige underscores the continued fragility and vulnerability of Italian banks. Despite first successful reduction measures, the volume of NPLs remains high. But there seems little likelihood of a swift, sizeable reduction to more acceptable levels given that the problem loans will only sluggishly recover value in the face of a recognisable but nonetheless feeble economic upswing. Furthermore, many of the banks are only able to make the disposals at unattractive, capital-eroding prices below book value. And further potential risk factors are looming on the horizon, such as the EU-wide bank stress test to be carried out again by the ECB and the EBA in 2018, with the results due to be released in early November. Should the NPL reductions be completed by then and the further measures proposed by the Italian banks for dealing with the high NPL volumes fail to meet the ECB’s expectations, the regulator could apply countermeasures and, for example, define reduction targets or even impose additional capital requirements under pillar 2. The stress test will also take account of the changes resulting from the introduction of IFRS9. Moreover, the parliamentary elections, due to be held in Italy by May 2018 at the very latest, also pose a risk for the stability of the banking sector. Even if we expect a Europe-friendly outcome to the election and a stable government to be formed, investor uncertainty could increase in the run up to the elections amid Europe-critical voices from some parties and an election campaign that will also most likely be fuelled by populist arguments.

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