Italy’s fragile economy was back in focus this week with investors closely monitoring the political landscape ahead of a referendum later this year and a new report suggesting that the country could be prepared to bypass European banking regulations.
The Financial Times reported Sunday that Italy was prepared “to defy the EU and unilaterally pump billions of euros into its troubled banking system if it comes under severe systemic distress … despite warnings from Brussels and Berlin over the need to respect rules that make creditors rather than taxpayers fund bank rescues.”
Citing “several officials and bankers familiar with the plans,” the FT said that the threat has raised alarm along Europe’s regulators “who fear such a brazen intervention would devastate the credibility of the union’s newly implemented banking rule book during its first real test.”
A spokesman for Italy’s Prime Minister Matteo Renzi denied the report, however, saying that “Italy has no intention of defying Brussels on the banks. We respect the rules and prefer market solutions for our banks,” Reuters reported.
Still, Italian banking stocks were among the worst faring stocks on theEuroStoxx 600 index on Monday with Banca Monte dei Paschi di Sienatrading down around 8 percent, Banca Popolare dell’Emilia Romagna down 6.8 percent, Unicredit down 4.5 percent and Ubi Banca down 4.3 percent.
EU banking union rules are designed to shift losses on to shareholders, bondholders and large depositors rather than taxpayers in the event of another financial crisis like the one experienced in 2008, when U.K. taxpayers largely bore the brunt of collapsing banks having to be rescued by national governments.
Italy’s banking system is considered to be one of the most vulnerable in the euro zone with a high level of non-performing loans (NPLs) – estimated to total 360 billion euros ($400.7 billion) – overshadowing the sector.
Societe Generale’s global research analysts led by Patrick Legland noted on Monday that Italy’s somewhat sclerotic banking system was “still fragile,” facing “specific headwinds related to the disposal of their NPL market, while bankruptcy processes and time for repossessions deter investors.”
As well as rising financial risks, Italy is also facing potential political instability in the coming months when it is due to hold a referendum on constitutional reform, a vote seen as a make-or-break event for Prime Minister Renzi, by the end of October.
Former Prime Minister Mario Monti told CNBC at the weekend that the referendum was a “gamble.” “It is true that Mr. Renzi made a bit of a gamble by unnecessarily putting his prime ministership on the line (in the case that) he loses the referendum,” Monti told CNBC at a conference in Aix-en-Provence in France.
The referendum is aimed at reforming (and reducing the power of) the Italian Senate and is designed to make it easier to govern. Deadlock in the lawmaking process is a persistent bugbear between the lower and upper houses of parliament in Italy, making attempts at reform a slow, tortuous process at a time when Italy’s fragile economy has needed it most. Italy emerged from almost two years of economic contraction in May 2015 but could still be vulnerable to a political shock should the referendum fail.
Citi analysts said in a note at the weekend that Italy’s constitutional referendum was “probably the single biggest risk on the European political landscape this year among non-U.K. issues, as PM Renzi’s political future may be tied to the outcome of the referendum.”
Citi analysts Tina Fordham, Ebrahim Rahbari, Giada Giani, Guillaume Menuet and Christian Schulz said that the vote is risky coming amid a rise in anti-establishment, populist sentiment, a factor that played a part in the recent U.K. referendum in which a slim majority voted to leave the EU.
“(The vote) raises the risk of Renzi-exit at a time when the upstart 5-Star Movement (M5S) are riding high in the polls and with Italy having among the highest levels of Eurosceptic sentiment,” the analysts said.
“If Renzi loses the referendum and resigns, the resulting domestic political instability could well trigger significant financial volatility in Italy and Europe, due to the lack of obvious alternative leaders and/or the rising likelihood of the anti-establishment M5S party entering the next government. Recent polls on the referendum outcome and the poor performance of Renzi’s PD (Partito Democratico) party suggest that it is far from assured that the referendum will go Renzi’s way,” they warned.