Italy’s Banking Crisis Poses a Threat to the Eurozone’s Recovery

Euromonitor International’s Italy Economy, Finance and Trade Country Briefing, focuses on Europe’s fourth largest economy (in US$ terms), which is undergoing a banking crisis, given poor capital ratios and a high propensity of loan defaults. After three consecutive years of protracted recession, the Italian economy witnessed slow recovery in 2015, which was driven by higher private consumption expenditure, low energy prices and prudent macroeconomic policies. However, economic recovery remains weaker than its regional peers. Additionally, excessive public debt levels and waning competitiveness could weigh on an already jittery economy’s overall output. Furthermore, being a major player in the region, worsening of Italy’s banking crisis could flatten the eurozone recovery.

Continued cuts in interest rates, in order to combat a deflationary trend, could further hamper banks’ profits and worsen Italy’s banking crisis:

• The European Central Bank’s (ECB’s) ongoing quantitative easing (QE) programme started in January 2015 is anticipated to last until March 2017, which should increase liquidity in the euro area. From April 2016 onwards, the ECB raised its bond buying from €60.0 billion to €80.0 billion per month until March 2017. Furthermore, in a bid to stimulate economic growth in the region and combat deflation, the ECB also cut the main interest rate to zero in March 2016;
• Inflation has continued to drop since 2012 and in 2015 annual inflation plunged to its record low level, owing to the fall in global oil prices since mid-2014, lower food prices and relatively weak demand. The country is expected to face deflation of 0.1% in 2016;
• In 2015, Italy’s nonperforming loans to total gross loans were 18.0%, one of the highest in the world. This has resulted in a large sell-off of bank shares that has been further exaggerated by the Brexit vote in 2016. Italy’s banking crisis could be aggravated by low interest rates that could hamper banks’ profits;
• Italy’s public-debt-to-GDP ratio continuously increased since 2010 and in 2015 it stood at 133%, which was the second highest in the EU, partially owing to high interest rates paid on the debt and a fall in GDP. However, with reduced interest payments and a steady rise in GDP, the public-debt-to-GDP ratio could gradually decline. Nevertheless, sluggish growth in productivity could slow down the process of reduction;
• An ongoing banking crisis might restrain credit provision that could challenge the implementation of various government planned infrastructure projects. Italy has a substantial elderly populace that is projected to grow significantly. Those aged 65+ could account for more than a quarter of the total population in 2030. Furthermore, the old-age dependency ratio is expected to increase from 33.4% in 2015 to 43.4% in 2030, which implies that the country will have to incur more healthcare and pension related expenses.

Italy’s ongoing banking crisis could reignite another eurozone crisis

In 2015, the proportion of nonperforming loans to total gross loans was the third highest in the eurozone, after Cyprus and Greece. This has resulted in a large sell-off of bank shares that has been further exaggerated by the ‘Brexit’ vote in 2016 and is impeding banks from lending. Furthermore, Italy’s banking crisis could be aggravated by continued cuts in interest rates, which could further hamper banks’ profits. The results of the stress test published by the European Banking Authority (EBA), in July 2016, have also confirmed the continued weakness in Italian banks, particularly the Banca Monte dei Paschi di Siena (one of the oldest and largest banks in Italy). The new EU rules in place since January 2016, has shifted the liability of rescuing stressed banks away from taxpayers and on to investors and this has complicated the situation even more. Thus, the government is looking for measures to resolve this issue in order to avoid a political crisis. Moreover, there are talks regarding the government’s plans on launching a €40.0 billion fund to rescue its banks, however, it has not been confirmed yet and remains ambiguous. Therefore, if Italy’s banking crisis is not resolved in time, there are fears of it spreading across Europe and disrupting the eurozone’s recovery.