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Italian Job

4 July 2016 by Gary Kirk

In October Matteo Renzi, the current Italian prime minister, is putting his political career at stake by holding a referendum which, he hopes, will give him a mandate to initiate structural changes to the Italian constitution; thereby enabling a more efficient process for passing legislation (currently the two houses, the Chamber of Deputies and the Senate bat potential rule changes back and forth, which can delay the process for years).

However, for Mr Renzi to stand a realistic chance of winning the referendum he has a major obstacle to clear first, which has brought him in conflict with the EU rule makers in Brussels and Berlin.

Non-performing loans in the domestic Italian banking system have been a well-flagged issue for some time. In a novel attempt to address this issue the Italian government proposed a state-sponsored (but privately backed) fund, Atlante, which will be used as a backstop for capital increases in failing banks. Atlante will also launch a fund to acquire non-performing loans from the regional banks with a view to securitising the loans and selling them to institutional investment houses.  In addition, funds from the state-owned Cassa Depositi e Prestiti are being considered to recapitalise any shortfall in the banks.

The European Commission and Berlin have both cried that this breaks the EU rules on state aid and the bail-in principles of the banking union; Benoit Coeure called the plan ‘breaking the banking union as we know it’. Mr Renzi replied that he will ‘not be lectured by the school teacher’. This is a major political stand-off which will test the EU and the diplomatic team who will look to find a workable solution.

One has sympathy for Mr Renzi’s position. The non-performing loans in question are not held at large investment banks, with the majority sitting in regional mutual and cooperative banks, backed primarily by retail investors. Mr Renzi cannot afford large scale bail-in of these investors and then hope to succeed at the forthcoming referendum; hence his commitment to fight the European Commission on this issue.

Will the European Commission try to force the issue and impose sanctions on Italy if it goes ahead with the state support? Well there have been precedents set in the past where the European Commission has requested the European Court of Justice (ECJ) deliver a ruling in respect of failures to transpose Bank Recovery and Resolution legislation. The Czech Republic, the Netherlands, Poland, Romania and Sweden have all been referred to the ECJ, where the court can impose daily penalties calculated according to payment capacity, duration and degree of seriousness. However, the ECJ is not known for the speed of its decision making process and the penalties are not necessarily overly punitive. It may well be that the Italians will go ahead and have their day in court but Mr Renzi will trade that off for victory in the referendum; which victory, in the long-run, is likely to be market favourable for all.

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