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The Next EU Crisis
Italy’s Troubled Banking Sector

Most Western media outlets have focused their attention on the political circus playing out in the United Kingdom after last week’s momentous Brexit vote, and as a result, they may be missing where the next domino is likely to fall in the evolving EU meltdown. Instead of gloating at Boris Johnson’s spectacular flameout and parsing the likelihood of a lasting split in Labour, journalists ought to pay more attention to the drama unfolding in Italy.

Last Monday, using the chaos unleashed by Brexit as a pretext, Italy’s Matteo Renzi asked his fellow European leaders to approve a suspension of the EU’s bail-in rules that would allow Rome to recapitalize its failing banking sector. As the Financial Times notes, EU leaders did not equivocate in their rejections of the initiative:

We wrote the rules for the credit system, we cannot change them every two years,” Angela Merkel, Germany’s chancellor, said on Wednesday in her first public comments since the Italian prime minister floated his idea on Monday. […]

…Benôit Coeuré, a European Central Bank board member, rejected the idea on Wednesday. “If you hold the bail-in rules in abeyance today, if that is the step you want to take, then it’s pretty much the end of market union as we know it,” he told Italian media.

Then, on Friday, a privately backed €5 billion bank bailout fund took control of a second Italian lender as nervous markets punished shares of Italian banks it considered undercapitalized. This, in turn, prompted to Italian authorities to consider schemes for propping up the rescue fund. Under consideration: raiding pensions. The FT again:

Meanwhile, Italy is considering increasing Atlante’s firepower by a further €5bn or more by drawing money from pension funds, the state or foreign investors, say bankers. Atlante is due to launch a second fund focused on buying NPLs next month.

Authorities in Italy are racing to create a bigger cushion for the banks before publication of stress test results, expected at the end of July. Senior bankers fear Italian lenders will emerge poorly from the tests, triggering another slide in share prices.

This should make people very nervous: private investors want nothing to do with many of Italy’s banks, badly undercapitalized and struggling under a burden of bad loans. The idea that the government would take peoples’ pension savings and put it into an investment which nobody else wants is the opposite of responsible governance. Anytime a government starts thinking of pension funds as a piggy bank which can be used for current needs, trouble is near.

The danger at this point isn’t that the banks would implode outright and usher in a new phase of Europe’s long-running economic crisis, but rather that the consequences of a weak economy and banking sector would precipitate a political crisis in Italy, bringing a euro skeptic government to power or producing an impasse that paralyzed Italy in the face of growing problems. Victories by Italy’s Five-Star Movement in recent mayoral elections have been interpreted as presaging just such an outcome.

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  • Andrew Allison

    Read http://www.zerohedge.com/news/2016-06-30/european-commission-grants-italy-crisis-%E2%82%AC150bn-bank-bailout-program-prevent-run-depo to see why Britain is right to exit. Renzi got turned down by the heads of the other eurozone countries, and the European Commission promptly went over their heads.

  • Observe&Report

    The paralysis of a political impasse would indeed be dangerous, but bringing a Eurosceptic government to power would be an excellent follow-up to the body blow the brexit vote has dealt to the Brussels elites’ arrogant delusions of pan-european grandeur. Depending on how the rerun of Austria’s presidential election goes, it could even be a triple-blow.

    • Andrew Allison

      We may well be witnessing a, much needed, slow-motion train wreck!

  • Kevin

    Wow – Merkle manages to hit just the worst sour spot time after time. Sort of the Calamity Jane of Euro-politics.

    The Europeans clearly need a rethink of what the hell they’re doing – doubling down on stupid for yet another decade is not the way forward. If they want tomorrserve the EU they need something flexible enough to allow Mediterranean and Germanic behaviors to coexist, trying to put both in the same straights met has clearly not worked – pretending Italians, Greeks, etc. are going to turn into German burghers tomorrow morning is a recipe for catastrophe.

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