What seems a politically ambitious step, may be one of the most sought-out solutions.
Non-performing loans in Italy are now common knowledge. Much has been written about the economy’s banking crisis, its spillover in the Eurozone, and its effect on global economics. The worst performer in Italy has been Monte dei Paschi di Siena, one of the largest banks in the country. Though temporary arrangements have been made for sustenance, there is a lot more to do.
The Eurozone as a whole, suffered from non-performing loans to the extent of 5.7 percent of non-performing loans to gross loans in 2015 (see main graph: Euro Area Non-performing loans to Total Gross Loans %). Bank failures affect taxpayers, and this is not news. The new EU rules state that private sources of capital (which include private taxpayers) are the first to be sought, when it comes to bail-in of the Italian banks. State acting as a source of bail-out for Italian banks, comes last. In Italy’s case, customers of the banks, predominantly households, seem the only sources of the bail-in that is required. Being remorseful of such ‘savagery’ earlier, Matteo Renzi was quick to ask for a government bail-in, in order to survive. In July this year, it was decided that, based on stress tests, a government bail-in would be considered. When the stress tests revealed a rather bleak picture of banks in Italy, especially Monte dei Paschi di Siena, a government bail-in was thought to be the only viable, if flamboyant solution. The bail-in may be linked to political schema in more ways than one. Renzi’s future as the Prime Minister, depends on the October Referendum, which will also take a strong stance on the economic future of the country.
Tracing back, Italy’s participation in the Euro as a currency denomination initiated several problems. Budging from a devalued currency and losing competitiveness in international trade, lesser spending on balanced regional development, political embroilment with its bicameral parliamentary system making it almost impossible to pass any reforms for economic growth and/or development, a low per capita GDP, which further decreased since the financial crisis of 2007-08, and a higher unemployment rate, have been only some of the problems.
Given the scenario, recapitalisation of Italian banks may seem appropriate. Two of the most significant issues that are addressed when recapitalisation is considered, are the reasons for it, and the depth of damage. The financial crisis hurt the global banking system to such an extent that it has been difficult to gauge the extent of damage in a conclusive manner. Recapitalising banks comes as a multi-level process that has both financial as well as behavioural results. On the financial side, there is high probability of the banks increasing their risk of insolvency, when there is recapitalisation. On the behavioural side, there is also a chance that the banks develop internal risk controls in order to receive capital injection, as per norms. If recapitalisation is to be done, even future losses must be estimated, and such that the government finances are not stressed excessively. Meanwhile, some economic reforms like labor mobilization, and improving the lending function towards new firms, must be addressed. This would prove a starting point to economic and political development.