Italy’s tottering banks

ITALY is the eurozone’s third strongest economy. It is a country with a post-war history of almost constantly revolving governments. Yet despite the political instability, economically Italy has been very far from a basket case. It is for instance, the home of one of the world’s leading automotive companies and the preeminent center of design and delightful cuisine. Effectively Italian business got on with business while governments after government tumbled. This had two important effects. Italian bureaucracy and indeed its legal system were left to their own devices and none of these devices was particularly fast nor efficient. Thus Italian tax collection and legal cases, whether criminal or commercial tended to go unresolved for extremely long periods. In the unusual event that the tax authorities went after someone for tax avoidance, it could be years before there was any conclusion, given a tortuous system of appeals. And given statutory limitations, tax defaulters often actually escaped. This was good for taxpayers but, as in Greece, extremely bad for government finances. Italy has long run a budget deficit which ought to have disqualified it from membership of the eurozone. However, because of the range of accommodations that allowed other countries, including Belgium, France and most fatally Greece to join without meeting the primary rules of budget deficit and proportion of national debt to gross domestic product, Italy’s problems were ignored. But though Italy’s chronic state finances are now a serious issue for the eurozone, the key problem is its banking system. The trouble lies in the fact that the country is over-banked. There are too many banks and these have high overheads in large measure because they operate too many branches. This structure is a reflection of Italian business. Despite the few big names like Fiat and oil company Eni, the preponderance of Italian industry is made up of small to medium-size specialist enterprises which historically have worked together and have close relationships with their banks. Since the financial crisis, banks and the businesses they support have been under increasing pressure. The star of Italian banking, Unicredit, which once aimed to build itself in part through aggressive acquisition into a global bank, epitomizes the problem of bad debts and shrinking new business opportunities. But the most high profile casualty has been the world’s oldest bank Monte dei Paschi di Siena which has a 23 billion euros portfolio of non-performing loans and a steady outflow of deposits from nervous customers. Attempts to raise 5 billion euros of new capital in the markets have failed. The government wants to bail the bank out but needs permission from the European Central Bank. That institution has checked the books and discovered that the bank actually needs more than 8 billion euro of new money. Though no one is saying it outright, the underestimation of the sum required smacks at best of wishful thinking but at worst of deliberate misrepresentation. Given that confidence is everything in the financial markets, the Italian banking system enters the new year in a highly vulnerable state, exacerbated by the rise of politicians disenchanted with the euro and indeed European Union membership itself. The collapse of one Italian bank could have domino effect which could reach beyond Italy’s borders to the rest of the eurozone, ultimately with dramatic consequences worldwide.