Global Economy / Italian banks undermined by local politicians

By Kensuke Nakazawa / Yomiuri Shimbun Staff WriterThe financial troubles of Italian banks have reemerged. This is mainly due to political instability in Italy following the resignation in December of Prime Minister Matteo Renzi, who sought constitutional revision but was defeated in a national referendum. Spreading populism is now starting to have negative effects on the real economy.

“[The referendum] doesn’t change the economic situation in Italy or the banks,” said Eurogroup President Jeroen Dijsselbloem, the finance minister of the Netherlands, the day after the referendum. “The problems that we have today are the same as yesterday.”

At a meeting in Brussels on that day, eurozone finance ministers were struggling to downplay the observation that Renzi’s resignation would lead to a financial crisis in Italy.

Italian bank stocks plunged the same day. Among them, UniCredit, the largest bank in the country, fell by more than 3 percent, and Monte dei Paschi di Siena, the third largest bank, fell by more than 4 percent.

The burden of nonperforming loans on banks in Italy amounts to about €360 billion (about ¥44 trillion) — about 30 percent of such loans across the entire eurozone and 18 percent of the total loans in Italy.

When the share of nonperforming loans in total bank lending remains high, banks tend to refrain from lending more out of fear it could aggravate the situation. This can lead to an economic downturn.

The European Central Bank on Dec. 8 decided to reduce the scale of its monetary easing. Interest rates have gone up as a result, which makes borrowing money more inconvenient. Some fear this may slow the economy.

However, nonperforming loans have been accumulating in Italy ever since the Lehman Brothers collapsed in 2008, against a backdrop of local politicians and bankers supporting each other.

In the central Italian city of Siena, where the headquarters of Monte dei Paschi are located, it is said that about 10,000 residents out of a population of about 54,000 either work for the bank or are engaged in related business.

As with this case, Italian banks have maintained a strong presence within their communities. Many banks are publicly run, and have had exceptionally strong ties with their hometowns.

A number of Italian banks were privatized in the 1990s in line with the country’s greater scheme to deregulate finance. However, to avoid being taken over by foreign capital, nonprofit foundations became their shareholders as a temporary measure.

However, these foundations have been in place ever since, and are deeply involved in the management of the banks as shareholders.

Although these foundations helped stabilize the banks by agreeing to increase capital during the financial crisis, they became the reason why disposals of nonperforming loans were deferred.

A report released by the International Monetary Fund in 2014 shed light on the structure of the problem, which had politicians from the banks’ local communities at its core.

To begin with, politicians would often send in people under their influence to work for these foundations. In the case of Monte dei Paschi, about half of the foundation’s board members were practically appointees of a local politician. The foundation, as a shareholder, could send its board members to the bank to participate in management. This would inevitably give the politician influence.

Meanwhile, the banks would pay the foundations dividends, which would then be used as funds to provide local governments or other institutions with grants and thereby return the bank’s profits to the local communities. What influenced the decision on “who gets how much” was again the intent of the politician deeply involved in the operation of the foundation.

In short, politicians and banks depend on each other through these foundations. Banks are susceptible to political interventions when they execute new loans or dispose of bad debts.

If money collected from depositors is earmarked for the growth sector and incompetent corporations are encouraged to exit, the flow of money will serve to boost the economy. In Italy, however, this path has been obstructed by the dark shadow of politics.

Yosuke Tsuchida, a researcher for Mitsubishi UFJ Research and Consulting, points out that “the weak corporate governance [of Italian banks] that involved prioritizing shared territorial bonds and blood relationships with borrowers is what aggravated the problem of bad debt.”

EU’s rigorous relief plan

One reason why Italian banks are still in dire straits has to do with the hard-to-use bailout scheme the European Union introduced in January 2016.

The “bail-in” regime, as the scheme is called, stipulates that banks, as a rule, must tap shareholders or bondholders before falling back on state funds. Bonds are issued by companies to procure funds. The aim of this scheme was to prevent state finances from deteriorating exorbitantly by rescuing banks.

In November 2015, before the new European rules were put in place, Italy applied the bail-in method to rescue four local banks including Banca Etruria. According to Reuters, about 12,500 investors consequently lost €430 million (about ¥52 billion).

In order to write off bad loans, as with Monte dei Paschi, governments can choose one of two options. One is to inject public funds based on a bail-in deal, and the other is to invite private funding.

If Italy were politically stable, private investors may have accepted a capital increase. However, due to the political turmoil accompanying Renzi’s resignation, investors seemed reluctant to provide capital.

The Italian government has opted to inject a state-backed bailout fund into Monte dei Paschi. However, the arrangement of this plan may face difficulty over how much of the burden should fall on bondholders.

Osamu Tanaka, chief economist at Dai-ichi Life Research Institute, says, “The key is whether the EU can be flexible enough, such as by granting exceptions to the bail-in rule in certain cases.”

The Italian economy has been in a prolonged slump. In addition to deferring the disposal of bad debts, political instability is preventing Italy from carrying on with the structural reform needed to boost its economy.

There has been 22 Italian prime ministers in the 36 years since 1980.

Senshu University Prof. Takeshi Ito pointed out that constitutional revision was rejected in the national referendum in Italy not so much because the people were against it, but because they were against Renzi himself. “The political factor had more weight,” Ito said. “In Italy, a fierce power struggle is in progress among different generations.”

The IMF, in a report released in July last year, stated that it may take until the mid-2020s for Italy to recover the scale of economy it enjoyed before the Lehman Brothers bankruptcy.

The political instability in Italy seems set to continue for a while longer. At this point, the future of its economy is hard to foresee.

(Additional reporting by Yomiuri Shimbun Correspondent Hiromi Uechi)Speech

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