Eurozone – Could Italy be a bigger threat to forex markets than Brexit?

According to analysts at Citi, Italy could be the biggest threat to Eurozone stability over the coming months as prime minister Matteo Renzi stakes his premiership on a referendum on constitutional reform, while a fragile banking sector risks plunging the country into financial turmoil.

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In a research note this week, the bank highlighted the twin risks stemming from Italy and Hungary as key geopolitical considerations for markets.

"Hungary (on EU refugee quotas) and Italy (on constitutional reform) will likely have referendums in H2 2016. The latter is probably the single biggest risk on the European political landscape this year among non-UK issues, as PM Renzi’s political future may be tied to the outcome of the referendum.

"We do not expect any other In/Out referendums on EU/Eurozone membership in an EU country in the near-term, despite rising EU- and Euro-scepticism across many countries. The reasons are that electorates cannot directly trigger EU referendums in most countries and that the authorities (usually Parliaments) that have the power currently appear unlikely to use it although in an environment of diminishing trust in elites, the temptation to seek political legitimacy through referendums is tempting."

Italy’s Banks

 

Italy’s banking sector is creaking and a significant failure could undo all the European Central Bank’s efforts to save the euro if not handled correctly.

Unlike other countries, Italy did not carry out a full spring clean of its banks post-Lehmans and there is trouble brewing with the country’s banks holding €360bn in non-performing loans - a third of all the Eurozone’s bad debt and about a fifth of all consumer loans in Italy.

Trading in shares of Monte dei Paschi di Siena was suspended on Tuesday after taking another tumble. The stock shuddered to an all-time low and a fresh bought of selling was enough to call a halt. Its shares have shed three-quarters of their value this year and is now valued at less than a tenth of its book value.

The lender has to dispense with another €10bn in bad loans and raise capital but this looks tough. UniCredit, Italy’s globally systemic bank, also needs to increase capital although its position looks less precarious.

But banks aren’t marking their assets correctly - BMPS’s bad debt is priced at about twice what the market value is, making it hard for the bank to offload.

Italy could bail out its banks and prime minister Matteo Renzi has hinted he is willing to use public funds to do so, in breach of EU rules if necessary. But such a clear intervention would deliver a major blow to new European banking rules and undermine what’s still a fragile system.  Moreover, many Italians were sold bank bonds without really being informed about the risks – a suicide of a Banca Etruria customer makes bailing in holders of bank debt almost impossible now.

Stress tests are due out later this month and it could be more bad news for Italian banks. Meanwhile, the state-backed Atlante fund is too puny in its current guise to have any real impact.

A bailout that meets current rules would likely mean haircuts for depositors and a potential run on banks that Rome wants to avoid at all costs.

Renzi wants to suspend state aid rules but so far Germany has refused. Ultimately a solution should be found quickly or the world’s oldest bank could fail and bring down the rest of Europe’s embattled banking sector with it. The EU needs to show flexibility or Italy could go under.