With Italy’s vote against constitutional reform, it appears Europe may have taken another notable step towards the breakup of the eurozone.
As with any vote, the reasons for voting ‘yes’ or ‘no’ are diffuse, but the anti-establishment sentiment that has coloured Brexit and the election of Trump has been on the rise in Italy too.
EU exit closer?
In essence, Italy’s vote against constitutional reform was a vote against economic reform within the eurozone according to Germany, and in the long run we believe it will leave Italy little choice but to quit the single currency area.
The European Central Bank (ECB) has already said that it stands ready to act to counter any instability in financial markets, and the governing council is almost certain to announce an extension of quantitative easing (QE) tomorrow.
Unfortunately, near-term political continuity and ECB liquidity can do nothing to solve Italy’s underlying problems. An unproductive asset base, combined with the existing cost structure, is leading to the continued erosion of the country’s balance sheet, most conspicuous in Italy’s zombie banks.
Propping up the Italian banking system with ECB liquidity, while postponing a banking crisis, does nothing to improve the economic prospects of the Italian economy, and the probability of a disorderly breakup of the euro over the longer term has increased.
Further pain ahead
Given the likelihood of continuing economic stagnation in Italy, our global research team summarises the outlook for Italian banks and some of the obstacles they face:
- Renzi’s loss of the referendum on constitutional reform comes at a time when many of Italy’s banks are struggling with bad debt issues, capital deficits, and a lack of profitability.
- Both Unicredit and Monte dei Paschi di Siena (MPS) need to raise capital, but face renewed uncertainty about the success of such capital raisings from the private markets given investor concerns about Italy’s political leadership in light of the referendum result.
- European rules on recapitalising banks prevent any support from the government without first imposing losses on bondholders, many of whom are the ‘man on the street’ retail depositors of the banks. Nevertheless, we expect the authorities to find a path around these rules as a state-supported bailout of MPS would seem to be the only viable solution remaining for the bank to raise the €5bn in capital it needs.
- We believe that without a full-scale clean-up of bank balance sheets, there is little chance that Italian banks will be able to resume extending new credit to the small business sector which is crucial to the Italian economy. Without a recovery in lending to the small business sector, there is little chance that Italy will be able to generate a rate of growth sufficient to arrest the worsening of bank non-performing loans (NPLs).
- In order to escape this negative feedback loop, which is hampering Italy’s escape from its economic malaise, a systemic solution to the large NPL stock is necessary; otherwise the already disappointing economic recovery is likely to slow further.
- Our portfolios have no direct equity investments in Italian banks and remain very underweight European banks, with no exposure to banks in peripheral Europe.