Crisis and opportunity

THE shockwaves from Brexit have been almost as severe on the Tiber as on the Thames. Markets fear that Britons’ vote to leave the European Union on June 23rd presages weaker growth in Europe and still-lower interest rates. That is not good for banks—and Italy’s, labouring under the EU’s heaviest bad-debt burden and tied to a frail economy, have been walloped (see chart). Shares in UniCredit, the biggest, have slid by one-third. Those of second-ranked Intesa Sanpaolo, though it is in far better shape, have shed 30%.

Most troubled is Italy’s third-biggest lender (and the world’s oldest): Monte dei Paschi di Siena, founded in 1472. Its shares tumbled on July 4th and 5th after the leak of a request from the European Central Bank for it to reduce its bad-loan pile from last year’s €46.9 billion ($52 billion), or 35% of all its lending, to €32.6 billion by 2018. (That was already the plan, said the bank, but the shares sank all the same.) It trades at around one-tenth of book value. Analysts at Morgan Stanley estimate it needs €2 billion-6 billion of extra capital.

Several European governments poured money into their banking systems in the wake of the financial crisis. Italy did not, partly in the misplaced hope that economic recovery would lighten its bad-debt load. The pile is now €360 billion, 18% of all banks’ loans, double what it was in 2011. After loss provisions (too low, say analysts) it is still €200 billion. The most “suffering” loans, or sofferenze, amount to €200 billion, or €83 billion after provisions. On July 29th EU supervisors are due to publish the results of their latest “stress tests” of 51 European lenders, which will not flatter Monte dei Paschi. It was one of nine Italian lenders to fail tests in 2014. Forced mergers, closures and capital raising ensued.

Matteo Renzi, Italy’s prime minister, wants to help banks shed their bad debts and recapitalise, with government money if need be. But European rules restricting “state aid” for companies have been tightened recently, making the task much harder. Since the start of this year, any bank receiving state aid is supposed to be put into “resolution”—in effect, bankruptcy. Shareholders and junior creditors must then be “bailed in” (ie, lose money) to the tune of at least 8% of the bank’s liabilities.

Mr Renzi wants to avoid that at all costs, because Italian banks’ creditors include millions of ordinary Italians. Households own around €200 billion of bank bonds eligible to be bailed in, which account for 5% of their financial assets. The stock is declining, because people are at last aware of the risks. A rescue of four tiny banks in November, in which bondholders were bailed in, caused widespread protests (one of which is pictured); one saver killed himself. A repeat may well seal Mr Renzi’s defeat in a referendum in October on constitutional reform, on which he has bet his premiership.

The stakes are high for the European Commission, too. It does not want its new rules to be bent the first time they are tested, nor does it relish a blazing row with a founding member of the EU so soon after the Brexit vote. So the search is on for a way to allow Italy to put public money into banks while sparing bondholders. There is wriggle-room: the rules allow a “precautionary” injection of state money to preserve financial stability without putting banks into resolution. A bad showing in a stress test is a possible justification.

That still counts as state aid, so should trigger a bail-in. One way around that, suggests Morgan Stanley, is to create a fund to compensate retail investors on the ground that the bonds were mis-sold in the first place. That may be not only expedient but also just: many investors were convinced that the bonds were as safe as legally guaranteed deposits.

Reports have suggested that Mr Renzi is contemplating a recapitalisation fund of €40 billion. But officials familiar with his plans say a far smaller sum is likely, probably less than €10 billion. That would be ample for recapitalising Monte dei Paschi and perhaps some smaller banks, and so could be a helpful step towards repairing the system. But it would still leave a lot of work to do.

Some banks will be able to raise capital on their own account if they need it. Analysts expect UniCredit, for example, to tap the markets and dispose of some businesses. The decision awaits Jean-Pierre Mustier, who becomes chief executive on July 12th.

But clearing up bad debts will take time. For lenders, sales and write-downs mean a painful blow: potential buyers rate the sofferenze at below 20% of face value on average, less than half of the written-down figure on banks’ books. Italian bankers complain that pressure from European regulators to act quickly will make a bad problem worse, by encouraging fire sales. Collateral consists largely of property: flats and commercial premises may be easy enough to sell in Milan or Rome, but much harder in less liquid markets in struggling areas. And repossession can take years—something a recent bankruptcy reform is intended to change.

One hope is that Atlante, a €4.25 billion fund set up in April with money from banks, insurers and other institutions to recapitalise small banks and securitise bad loans, can take more of the strain. But €2.5 billion has already been spent on shares in two ailing northern banks, leaving little in the kitty. Moves are afoot to boost Atlante, perhaps with a new bad-debt fund of €3 billion-5 billion.

The answer to Italy’s banking problems seems sure to involve more capital—from whatever source—more asset sales and more write-downs, as well as consolidation of smaller lenders, which the government is encouraging. But even that may not be enough. It is hard for banks to thrive if the economy around them does not.