Italy’s Bank Rescue Foreshadows Nationalization of More EU Banks

On December 7, 2016, Italy’s Prime Minister Matteo Renzi resigned following defeat in a national referendum, that he had supported, that would have changed the country’s parliamentary system. The development, which represents just the latest sign of anti-EU sentiment spreading throughout Europe, was felt acutely by Italy’s troubled banking sector. In particular, the Banca Monte dei Paschi di Siena (MdP) has been teetering on the brink of collapse and now may stand as a case study that may be encountered by other EU member nations. The advent of the euro currency allowed Eurozone member countries, even those with poor financial health like Italy, to borrow at far lower ‘Germanic’ interest rates than their respective national credit ratings would have allowed. In turn, national borrowers were able to tap into the vast sums of liquidity created under central bank quantitative easing (QE) programs at astonishingly low, and sometimes negative, interest rates. Predictably this has led to a massive misallocation of capital, and billions in potentially non-performing loans. The problem for Italian banks became particularly acute when the fall of the Renzi government raised the possibility that a new Government could seek to lead Italy out of the Union and bring back the lira to Italy. With the return of its own currency, future Italian governments could devalue at will in order to pay the country’smounting debts. If faced with the possibility that their euro-denominated deposits could be transformed into shrinking lira deposits some could be convinced to transfer funds into German banks where they would face no such peril (EU laws present no obstacles to cross-border banking). This is a clear recipe for a banking default.

This post was published at Euro Pac on Wednesday, January 25, 2017.