Blog Post

Financial implications of the Italian referendum

On Sunday, Italy will held a constitutional referendum whose implications for the political stability of the country are uncertain. Right after the referendum, Italy’s oldest and most troubled bank - Monte dei Paschi di Siena - is expected to complete a very important and sizable capital raise. Here we look at the situation and implications of this critical juncture.

By: and Date: December 2, 2016 Topic: European Macroeconomics & Governance

On Sunday, Italians vote in a referendum to decide whether an amendment to the Constitution proposed by the government should be implemented or not. The vote is not about any financial or economic issue, but its timing and its potential implication for political stability are such that a negative outcome could trigger some financial instability.

Italian banks are still bearing the burden of a significant load of non-performing loans (NPLs). We have discussed the issue of NPLs in the Italian banking sector several times before (see e.g. here and here), and there is not much new on this front. As of September 2016, the Bank of Italy was reporting that the total of bad debts in the system was €198.9bn, down from €200bn in August. Table 1 shows updated 2016Q3 gross NPL ratios for some of the biggest Italian banks, showing that the situation is diversified. While some initiatives (such as the guarantee scheme GACS) have been taken recently, these will likely take time to bear fruit.

The elephant in the room is obviously Monte dei Paschi di Siena (MPS), with its 35% NPL ratio, and a capital raise operation looming at the end of the month. I have discussed the specific problematics of a potential MPS resolution here – particularly highlighting the point that 65% of MPS’ total outstanding subordinated debt is held by retail savers, making a bail-in focussed resolution within the BRRD framework potentially very painful. Back in July 2016, I had argued that the best solution for MPS would have been a precautionary recapitalisation with burden sharing for junior debt, protection of senior creditors and a credible reimbursement scheme for those who were wronged due to unlawful practices which should have been better prevented.

The choice was different, specifically to go for a disposal operation on NPLs which hinges on a capital raise of €5bn from private investors. The fear of a potential political backlash from a bail-in of subordinated retail debtholders possibly played a role in this decision, in view of the planned referendum. The fact that the capital increase was scheduled for December 2016 – after the referendum – is probably further evidence in support of that. But this choice now puts the bank in a very difficult and uncertain situation, for a number of reasons.

To put things in perspective let’s first note that a capital increase of €5bn is big in itself: it  amounts to almost 10 times the value of the bank’s current market capitalisation (which is around €600m). To this, the bank is adding a €4.3bn debt-to-equity swap offer, which will run from 28 November until 2 December The bank reportedly communicated to Consob – the Italian public authority responsible for regulating the Italian financial markets – that it expected a take-up of this offer for about €1bn, 25% of the total.

A second problem is timing. The operation is supposed to be initiated right after the referendum, and this has become risky, in view of the uncertainty mounting on the outcome of the vote. Opinion polls now point increasingly to a victory of the NO camp. If this were to happen – especially if NO were to win by a significant margin – the Prime Minister would likely resign and the opposition parties would be strengthened. After amendment of some aspects of the new electoral law – which was drafted in tandem with the constitutional amendment on which Italians are voting – new elections would be held.

The potential consequences of such a situation for financial stability are twofold. First, there would be a transition period that could drag on for a long time. All parties would likely try to pull the amendment of the electoral law in a direction that benefits their electoral prospects. During this period any reform effort would essentially be frozen, and in a country like Italy this is hardly good news.

Second, the outcome of the ensuing elections – with a strengthened 5 Star Movement and possibly a comeback of the centre-right – would heighten political and economic uncertainty. For starters, the idea of a referendum on Italy’s membership of the EU or Euro would probably be central to the 5 Star Movement’s campaign and possibly for the Northern League as well. Contrary to what many seem to believe, such a referendum is not something that can happen overnight. Article 75 of the Italian Constitution in fact states that the ratification of international treaties cannot be subject of a referendum. The Constitution can be amended – we are seeing it now – but it requires gathering a considerable majority in the Parliament and in the country.

Yet, the fact remains that this would be a complicated and uncertain situation, and in this context investors’ interest in the MPS operation could evaporate (and the success of the NPL dismissal operation with it). Attracting foreign capital in politically uncertain circumstances could be already difficult, and the prospect of a potential surge of the 5 Star Movement could complicate things even further, as the prevalent opinion among its members is that MPS shoudl be nationalised. The bank is reported to have communicated to Consob that there is “no plan B” under study. And admittedly it is hard to see what alternative option would be there, aside from the one discussed this summer.

So the solution to the MPS issue may in fact be back to the option that was available but not taken six months ago, although this “tactical” delay would not be inconsequential. Uncertainty may in fact create spillover effects on other Italian banks, whose NPL situation is also not yet resolved and who are part of a strongly interconnected system. As a matter of fact, interconnection has increased further recently, due to ventures such as the bank-funded Atlas fund that has been acting as a underwriter of last resort in the capital raises of several troubled small banks and that we have discussed at length here. Incidentally, one of the early proponents of the Atlas fund has recently admitted that in hindsight it would have been better not to participate.

So, in conclusion, almost six months after the most recently released ECB’s stress tests, the situation of the Italian banking system looks still very uncertain. In the case of a NO victory in the referendum, the success of the planned recapitalisation of MPS is at risk. At that point, the solution to the MPS problem may – somewhat ironically – be back to the one that was available six months ago. But this time there would be the downside of having to take action in a context of heightened political and economic uncertainty. This could create significant spillovers for the rest of the banking system. For now, all we can do is wait until Sunday, and see.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article More on this topic
 

Blog Post

Growth uncertainty, European Central Bank intervention and the Italian debt

European Central Bank intervention provides a buffer against the uncertainty faced by European Union economies in the face of COVID-19. For the time being, this intervention has alleviated concern about Italy's debt, but without it Italy is vulnerable to a debt crisis.

By: Andrea Consiglio and Stavros Zenios Topic: European Macroeconomics & Governance Date: October 28, 2020
Read article More on this topic
 

Opinion

Why OMT is not the solution for Italy right now

The Outright Monetary Transactions tool is not well suited for Italy right now. Italy needs fiscal support both by itself and by the EU. Italy and the rest of the EU need a fiscal bazooka. We should find a way of backstopping our economies immediately.

By: Maria Demertzis and Bruegel Topic: European Macroeconomics & Governance Date: March 16, 2020
Read article More on this topic
 

Blog Post

To save the Italian economy from the Coronavirus, Rome prescribes a stimulus

Faced with a difficult prognosis, the Italian government has prescribed a three-step strategy to treat the worse economic symptoms of the Coronavirus. The medicine is money and the dosage is €4.5 billion

By: Simone Tagliapietra and Bruegel Topic: Global Economics & Governance Date: March 3, 2020
Read article More on this topic
 

Opinion

Under swollen tides, Venice says more about our future than our past

While tides high enough to submerge Venice used to be rare, occurring every two to three decades, they have now become increasingly regular. Five of the ten highest tides in recorded history occurred over the last 20 years, with the most recent one having occurred just last year. Is this the new normal?

By: Simone Tagliapietra and Bruegel Topic: Energy & Climate Date: November 18, 2019
Read article More on this topic
 

Blog Post

Talking about Europe: La Stampa 1940s-2010s

An on-going research project at Bruegel seeks to quantify and analyse printed media discourses about Europe over the decades since the end of the Second World War. In this third blogpost, we carry out the exercise on 9.9 million articles from an Italian daily newspaper, La Stampa. The trend increase in the frequency of European related articles, previously found looking at the French and German press, is confirmed in the case of Italy.

By: Enrico Bergamini, Emmanuel Mourlon-Druol, Francesco Papadia and Giuseppe Porcaro Topic: European Macroeconomics & Governance Date: October 22, 2019
Read article More on this topic
 

Opinion

Why Europe needs a change of mind-set to fend off the risks of recession

Recession! This is the new worry in Europe and the US. A simple look at google trends shows that in Germany, France and the US, search interest for recession peaked in the last weeks. In Italy, the peak already occurred end of January. Whether a recession is actually occurring is difficult to gauge in real time. But there can be no doubt that significant risks such as the trade war and no-deal Brexit exist.

By: Bruegel and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: September 2, 2019
Read article More on this topic
 

Blog Post

‘Lo spread’: The collateral damage of Italy’s confrontation with the EU

The authors assess whether the European Commission's actions towards Italy since September 2018 have had a visible impact on the spread between Italian sovereign-bond yields and those of Germany, and particularly whether the Commission’s warnings have acted as a ‘signalling device’ for bond-market participants that it might be difficult for Italy to obtain the support of the ESM or the ECB’s OMT programme if needed.

By: Grégory Claeys and Jan Mazza Topic: European Macroeconomics & Governance Date: July 8, 2019
Read article More on this topic
 

Blog Post

GNI-per-head rankings: The sad stories of Greece and Italy

No other country lost as many positions as Greece and Italy in the rankings of European countries by Gross National Income per head, between 1990 and 2017. The tentative conclusion here is that more complex, country-specific stories – beyond the euro, or the specific euro-area fiscal rules – are needed to explain these individual performances.

By: Francesco Papadia and Bruegel Topic: European Macroeconomics & Governance Date: June 18, 2019
Read article More on this topic
 

Blog Post

Uncertainty over output gap and structural-balance estimates remains elevated

The EU fiscal framework strongly relies on the structural budget balance indicator, which aims to measure the ‘underlying’ position of the budget. But this indicator is not observed, only estimations can be made. This post shows that estimates of the European Commission, the IMF, the OECD and national governments widely differ from each other and all estimates are subject to very large annual revisions. The EU should get rid of the fiscal rules that rely on structural balance estimates and use this opportunity to fundamentally reform its fiscal framework.

By: Zsolt Darvas and Bruegel Topic: European Macroeconomics & Governance Date: June 17, 2019
Read article More on this topic
 

Opinion

Takeaways from Xi Jinping’s visit to France and Italy and ideas for the EU-China summit

The author appraises China's strategy towards Europe ahead of next month's EU-China summit.

By: Alicia García-Herrero and Bruegel Topic: Global Economics & Governance Date: March 27, 2019
Read article More on this topic
 

Blog Post

The higher yield on Italian government securities is becoming a burden for the real economy

Francesco Papadia and Inês Gonçalves Raposo have recently written on Italian fiscal policy and the increase in the spread between Italian (BTP) and German (Bund) government. Since then, two developments have taken place: one good, and one bad. This blog post reviews them.

By: Francesco Papadia, Inês Goncalves Raposo and Bruegel Topic: European Macroeconomics & Governance Date: February 5, 2019
Read article More on this topic
 

Opinion

The great macro divergence

Global growth is expected to continue in 2019 and 2020, albeit at a slower pace. Forecasters are notoriously bad, however, at spotting macroeconomic turning points and the road ahead is hard to read. Potential obstacles abound.

By: Jean Pisani-Ferry and Bruegel Topic: Global Economics & Governance Date: December 5, 2018
Load more posts