LONDON – As Italy approaches what promises to be one of its most contentious general elections since 1945, banks are the elephant in the room. Too big and cumbersome to be ignored, they are a constant source of embarrassment for the parties that have been in government since the global financial crisis of 2008, especially for former Prime Minister Matteo Renzi, who hopes to rekindle his political career in March. They are also an inviting anti-establishment target for the populists of the Five Star Movement.
Indeed, Italy’s banks epitomize all the problems that the financial crisis brought to the country, and on which the populists are capitalizing: a double-dip recession followed by sluggish GDP growth, high unemployment, especially among the young, and a collapse of domestic demand. Banks also embody the tangle of vested interests, malpractice, and even corruption that, together with la dolce vita, have come to be associated with Italy.
Despite the bail-in of four local banks, the bailout of Monte dei Paschi (one of Italy’s systemically important banks), the liquidation of two regional banks, and the market-led rescue of the mid-size banking group Carige – all within two years – the banking system has yet to be stabilized. Will the underlying economic recovery – this year and next, the Italian economy should grow in real terms by 1% – assist Italy’s banking sector by keeping a lid on a stock of non-performing loans (NPLs) totaling nearly €180 billion ($220.9 billion)? Or should the recovery be used to clean up wobbly banks’ balance sheets, by bundling their NPLs and selling them at a discount?
Before the global financial crisis, Italy was described as a country of solid banks that were rooted in the local economy and never played with exotic financial instruments such as derivatives. It was also said to be a country of prudent savers, who buttressed the profligate public sector and its expanding debt.
In the aftermath of the collapse of Lehman Brothers in September 2008, Italy’s then-finance minister Giulio Tremonti famously endorsed the health of the country’s banking system. As a result, a major recapitalization of Italian banks and the creation of a “bad bank” to absorb NPLs were deemed unnecessary.
Ten years later, Italy is no longer that imagined land of prosperous banks and happy savers. The prolonged recession and economic malaise have dented the individual savings rate, while banks no longer have the resources to provide peace of mind to many retail investors, whose trust has been severely eroded.
The implicit pact between banks and savers was broken in late 2015, when four troubled local banks were bailed in and the shareholders took the hit. For years, this pact had underpinned Italian-style financial repression, whereby risk-adverse savers traded safety, implicitly assuming that banks could not fail, and accepted relatively low real returns. The political backlash that ensued from the bail-in triggered a blame game between the government and the opposition parties, and even between politicians and regulators, with all blaming the European Union and its banking regulations.
The government that emerges on March 4 will have to make the banking sector a high priority. In order to restore confidence among savers and investors, it will have to find a solution to clear banks’ balance sheets of NPLs, which are undermining credit, making capital more expensive, and thus acting as a drag on the economy.
The solution must be market-led, as the volume of NPLs is far too big, and the recovery far too slow, for this debt to be gradually absorbed. The new government thus may need to identify cases where NPLs hinder banks’ normal functioning, sell this debt, and prop up the capital of the affected banks. At the same time, civil bankruptcy procedures will need to be reformed, to ensure the reasonably fast action on defaulted borrowers’ assets.
If confidence and credibility are to be restored, sound governance has to be put at the core of the next government’s plans for banks. Over the years, regulatory lapses, lack of board independence, and a good dose of financial repression turned many banks into channels to fund family members, friends, and political associates.
Monte dei Paschi, for example, was long associated with the center-left Democratic Party, which has been in government since 2013. This political association may have prolonged the bank’s saga for several years, until it had become so battered by inconsistent piecemeal interventions that a market solution became impossible. Following last year’s bailout, Italy’s Treasury owns about 70% of the bank.
Restoring market credibility also means clarifying banks’ role in the economy. If they provide a public good – that is, credit to the real economy – should they be part of a broad-based long-term economic policy strategy for the country? And, in an economy with approximately 600 small independent banks and too many branches, should consolidation be encouraged and supported?
Any effort to put Italy’s banking sector on a sounder footing will require a stable majority government, consistent determination to put economic growth at the center of the political agenda, and willingness to confront Italy’s many vested interests. Unfortunately, none of the parties has so far come out with a comprehensive, credible economic agenda. And none so far seems capable of winning or delivering a parliamentary majority.
The most likely scenario, then, is that Italy’s zombified banks will continue to feed the populist electoral narrative. And if that narrative fuels a populist victory in March, reform of the banking sector will again be postponed, raising the eventual cost still further.
Paola Subacchi is a senior fellow at Chatham House and visiting professor at the University of Bologna.
Copyright: Project Syndicate.