Unresolved Non-Performing Loans In Italian Banks Risks Derailing The Euro Area Economic Recovery

Fotios Raptis, Senior Economist | 416-982-2556

July 26, 2016 |

Highlights

  • Markets have recently shifted attention away from the UK and toward the health of European banks in the lead-up to stress test results scheduled to be announced at the end of this week. Italian banks are not expected to perform well due to the large amount of non-performing loans (NPLs) on their balance sheets. 
  • Over the past two years, Italian authorities have been working toward a solution to recapitalize the bank sector by laying the foundation for much needed legal and banking sector reforms, including engaging the private sector for a market-driven solution. Despite their efforts, Italy is still far from a solution fully compatible with the EU’s bank resolution framework that came into effect this past January. 
  • We anticipate that an eventual resolution to the NPL problem plaguing Italian banks will require a compromise between Italian authorities seeking support for retail bondholders and the resolution directives set forth by the EU. Legal reforms, bank consolidation, private sector investment with state backing, as well as some support for retail bondholders are all likely to feature in the agreement. 
  • Given the fragile economic recovery in Italy, a recapitalization of its banking sector in an environment of low inflation and highly accommodative monetary policy is a necessary condition to ensuring the transition to sustainable economic growth. The risks of delaying action cannot be overstated. As the Euro Area’s third largest economies, a banking crisis in Italy would spillover to its major trading partners, jeopardizing the viability of the currency union.

 Full report in PDF format is available here.

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