The Next EU Crisis
The European Headache That Can’t Be Wished Away

Defenders of the EU status quo have allowed themselves a sigh of relief this weekend, after the election of Emmanuel Macron in France and the strong showing of Angela Merkel’s CDU in the German state elections. Meanwhile in Italy, the markets have considerably less reason for cheer. Financial Times offers a look:

Italy’s financial system remains one of the unresolved weak links in a European economy finally showing signs of recovery, with the government struggling in its effort to address a long stagnation that has eroded the ability of Italian businesses and consumers to repay debts.

Over the past year, bankers have worked vigorously to devise ways of selling off the exposure to non-performing loans held by banks using securitisation in which the loans are packaged up and sold on to investors.

However, significant securitisations of NPLs have failed to materialise and Italy’s loan problem is barely improving. The overall stock of bad loans for 15 Italian banks fell in 2016 for the first time in the past eight years, according to DBRS, the Canadian rating agency, which analysed the lenders’ results. Yet the proportion of so-called sofferenze — the worst class of bad loans, where banks are exposed to insolvent borrowers — had risen slightly.

There is a sliver of good news here in the overall decline of non-performing loans, but the larger problem is more troubling. Italian banks are still struggling to clean their balance sheets of toxic assets, and unlike Spain and Ireland, Italy has failed to develop a viable securitization scheme to attract private investors. The EU, for its part, has been of little help, resisting the previous government’s entreaties for a suspension of EU rules so that Rome could recapitalize its banks, while balking at Italy’s December decision to bail out the Monte Paschi bank.

In short, Italy’s financial sector remains weighed down by bad loans it cannot get rid of, causing a drag on the economy at large, and it may require further capital injections that Berlin and Brussels are unwilling to provide. With elections looming next year, that combination of economic stagnation and European stinginess is likely to fuel the anti-EU anger currently on the rise throughout Italy.

Indeed, as the FT notes elsewhere, the Five Star Movement’s Bepe Grillo is already using Macron’s election to double down on his anti-EU rhetoric and calls for an Italian exit—and the message seems to be resonating. The FT again:

“Europe will see another government coming out of the banks,” Mr Grillo wrote. “More precious time will be wasted to benefit this plastic formation, these dummies who are slaves of an impossible currency,” he added. […]

Five Star is currently slightly ahead of Italy’s ruling Democratic party in opinion polls, with the backing of about 28 per cent of Italians, making it one of the strongest populist parties in Europe. It has called for a referendum on exiting the euro.

Those cheering a few centrist electoral victories as proof that the EU is on solid footing, should look to Italy for what may be the EU’s next major battleground. If Europe’s technocrats cannot provide answers to the economic trials and populist discontent of Europe’s south, the fissures eroding the union will only continue to grow.

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