Italian Bank Failures Could Disintegrate the EU

Yves here. Even though the Italian government managed to cobble together a rescue for its number three bank, Monte dei Paschi, the Italian banking system is still very much on the rocks, as this Real News Network interview discusses in detail.

SHARMINI PERIES, TRNN: It’s the Real News Network. I’m Sharmini Peries coming to you from Baltimore.

Another banking crisis looms on Europe’s horizon, but this time it will unfold from Italy, Europe’s fourth-largest economy, where loan defaults threaten to endanger not only Italy’s economy but all of Europe. There are over 300 billion euros in bad loans in the banking system, which represents about 18 percent of all loans, which is an unusually high level when compared to other countries. For example, less than 5 percent of France’s loans and only 1.5 percent of Germany’s loans are considered to be bad.

After the 2012 banking crisis, the European Union passed rules that require bank shareholders to pay the bailout before EU intervenes. In Italy’s case, the shareholders tend to be small, private households that stand to lose a significant amount of their savings. But did the banks fail or whether they are bailed out by their shareholders, the government of Prime Minister Matteo Renzi stands to lose no matter what happens. Let’s have a look at what the president of the Banco Popolare di Milano, the supervisory board member, Nicola Rossi, had to say about all of this.


With us to discuss the situation in Europe is Dimitri Lascaris and Gerald Epstein. Dimitri is a class action lawyer and currently the justice critic in the shadow cabinet of the Green Party of Canada. He’s also a board member of the Real News Network. Good to have you with us, Dimitri.

DIMITRI LASCARIS: Thank you, Sharmini.

PERIES: And Jerry Epstein is co-director of the Political Economy Research Institute and professor of economics at UMass Amherst. Thank you so much for joining us, Jerry.

GERALD EPSTEIN: Good to be here.

PERIES: So Gerald, I’m going to go to you first. The latest so-called stress test of European banks are about to be released, or will be by the time we publish this. And it is widely expected that they will show just how bad this situation is in Italy. How bad is it, Jerry?

EPSTEIN: Well it’s very bad for these banks. And as you said in the intro, that means it’s also very bad for people of Italy, especially the people who lent money to these banks, and the government. The banks–but I’m not sure the stress tests themselves will actually reveal how bad it is. In fact, there’s some evidence that the stress tests themselves might softpedal it, but we can come back to that.

For the banks themselves, as you said, they have somewhere between 20 percent and by some measures 40 percent nonperforming loans. It’s well understood that several of them are essentially bankrupt and need a bailout. But as you also said, the new rules in the European Union prevent governments from bailing them out, unless they first, the creditors first lose their money. Which means in this case some big investors, but also a lot of small Italian investors.

So there’s a standoff. The European Union is insisting on this. But the government says no, we can’t impose these kinds of costs on our people. And we need to bail out the banks. And at the same time, everybody’s tired of all of these bank bailouts, so it puts the government in a very precarious position.

PERIES: And Dimitri, let me let you get in on this. We are coming from the experience of the Greek banks, but what’s actually taking place, here?

LASCARIS: Well, these stress tests–this is going to be the third round of stress tests conducted by the European Banking Authority. Stress tests were conducted in 2011 and 2014. The last round in 2014 looked at about 130 banks, and the EBA, the European Banking Authority, gave a pass or grade fail to each of the banks. And only one bank, [inaud.] of Italy, the third-largest lender and the oldest bank in Europe, failed. All the others passed. And collectively the EBA claimed that the capital requirements for the 130 or so banks that were examined were about 25 billion euros.

As Jerry quite rightly indicated, there was a lot of skepticism around these numbers and these results. And in fact, three academics from, one from–[inaud.] of the Center for European Economic Research, [inaud.] from New York University, and [inaud.] of the University of Lausanne, issued a study in 2014 in which they concluded that the actual capital requirement was in excess–of 130 banks that were tested–was in excess of 770 billion euros, or more than 32 times, approximately 32 times what the EBA had claimed they needed.

This time around there are even more serious questions surrounding the plausibility of these stress tests, because the EBA is not going to give a pass or fail grade, and it’s only looking at about 51 banks. And that means that the effect of its decision, or the parameters of its study, is that banks from Greece and Cyprus and Portugal, which are really, especially in Greece and Cyprus, in horrific condition, are not included in the stress test.

What’s interesting about the explanation for not giving a pass or grade fail, which is the–let me read it to you so you know what the justification is. The EBA says: the objective of the crisis stress test was to identify possible capital shortfalls and require immediate recapitalization actions. And this is the key language: as banks have now moved to a more steady-state setting, the aim of the 2016 exercise is rather to assess remaining vulnerabilities and understand the impact of adverse market dynamics on banks.

So what–putting aside what “move to a more steady state setting” means, whatever it means, it seems difficult to accept as a factual proposition that banks are now in a more steady state setting. The banks in Europe have just been eviscerated by share prices, have been eviscerated this year. Deutsche Bank, which is identified by the IMF as the riskiest big bank, and the largest lender in Europe has seen its stock price fall by something in the range of 50 percent this year. The Italian banking sector has seen its market capitalization decline by over 50 percent this year. The banks in Europe are operating in a very challenging environment because there are ultra-low interest rates which are eating into their lending profit margins.

And the Brexit vote isn’t helping. It’s created additional uncertainty which, by the way, is not going to be examined in these tests. So if you look at what’s actually happening in the European banking sector, the idea that they’re in a steady state is highly dubious. And the absence of a pass or fail grade raises real questions about the legitimacy of these tests. And you know, to sort of add fuel to the fire, these three academics have now, the ones I mentioned previously, have come out with a new study in which they estimate–and what they do in this study is that they look at something that the EBA has not been looking at. They ask, what’s going to happen? What will the capital requirements be if there is a 40 percent drop in global stock markets in six months?

And that’s, something in that magnitude happened just a few years ago in 2008-2009. So this is not an implausible scenario. And they conclude that the banks, the 51 banks that are being examined, would need a capital nexus of 900 billion euros, and that even if the bailing mechanism were employed, certain of these banks would still require government support. So it will be very interesting to see what these results show tonight. I suspect that the number we’re going to be given is going to be nowhere near 900 billion euros. That would be very surprising.

PERIES: So, Jerry, it looks as if, based on what Dimitri and you have just said, that the major banks will have to be bailed out one way or another. What does this mean for Italy and for ordinary Italians? It’s one thing, and after all, as we knew several countries in Europe will also face the consequences of all of this.

EPSTEIN: Well, if a bailout has to occur, and we don’t know for sure that it will, but at least in the case of Italy it seems–or at least some of the banks, likely–it creates a big problem for Italy as it did for Greece. Because among other things, it’s in the eurozone. And there are all these fiscal limits and requirements. And if they have to use some of that fiscal space to bail out the banks, that means that their debt problems and their austerity problems will get even worse, because they won’t have the fiscal space to provide other kinds of government spending.

And in fact, if you look at the causes of all this, you go more deeply, we see that the economic crisis caused by the banks in the first place, and the austerity imposed by the eurozone and the euro rules are really at the root cause of this. In Italy, GDP has fallen more than 10 percent since 2007, when the crisis started. Industrial capacity has fallen by 20 percent. The IMF isn’t predicting that the GDP growth in Italy is going to reach what it was in 2007 until 2025. So you have austerity and stagnation for as long as the eye can see.

So unless something dramatic changes, this is just going to pile on one set of misery and austerity on the Italian people, and other Europeans on top of the other.

PERIES: Right. So let me go to Dimitri, here. Dimitri, we’ve learned a lot from Greece. And what are the takeaways, what options are there, that could be implemented here that wouldn’t have the same effect it did in Greece?

LASCARIS: Well, I think, you know, I have to embrace enthusiastically what Jerry said about austerity. The EU’s austerity fixation is creating an extremely challenging economic environment, particularly in countries in the Mediterranean basin, like Greece and Italy, and Spain and Portugal. And that is piling pressure on these banks. It’s, you know, causing their non-performing loans to soar. In Italy the non-performing loans of the banking sector are currently in the range of 17 percent. Only Greece, Cyprus, Slovenia, and Portugal have higher rates of non-performing loans. They’re actually astronomical. In Greece I think they’re in the range of, like, 40 percent and Cyprus around 50 percent.

This is all intimately tied to the austerity program, of course. And so the EU is, you know, adopting economic policies that are hammering the banks. And then turning around and saying, well, we’re going to throw up impediments to governments bailing them out, even when failing to do so could have very adverse impacts on people who are in an economically more vulnerable position.

I think if we see the EU prevent a resolution in Italy that is going to protect particularly small bank investors, this is only going to serve to increase animosity towards the European Union in Italy, which is already climbing, as it has, probably throughout the European Union. It’s just going to be one more nail in the coffin of the so-called union the Europeans sought to construct decades ago.

So it’s a very challenging situation. Very much of the EU’s and ECB’s own making. And it is, in my view, it has the potential to exacerbate the forces right now that are leading to the disintegration of the European Union.

PERIES: And Jerry, what alternatives are there? What can the European Central Bank do that tries to ensure that what happened to Greece and other countries that Dimitri just mentioned isn’t what we’re going to see in Italy?

EPSTEIN: Well, austerity isn’t the answer, as Dimitri said. And so there are very strict rules on what the European Central Bank can do. But essentially, these banks that are in such trouble have to be nationalized. The ones that are causing so much problem. Nationalization. And then used to invest in the economies, lend to small business, invest in infrastructure, and so forth. And then the only other solution is to figure a way out of this austerity trap, because short of that there’s not going to be a long-term solution.

LASCARIS: The one thing I would add to what Jerry said–I suspect, Jerry, you would agree with this–is that once these banks have been nationalized, whether they’re nationalized or not, their management should be removed.

EPSTEIN: Oh, absolutely.

LASCARIS: Yeah. You know, this is a major criticism of the bailouts that happened in connection with the 2008-2009 financial crisis. I mean, these people were allowed to stay in place, people who had at a minimum been grossly incompetent in the management of these banks, and perhaps even worse, had behaved in an outright fraudulent manner. And it contributed enormously to this catastrophic financial crisis that the world experienced.

You’ve got to get rid of those managers. And I don’t see any real appetite amongst the European elite for doing that at this stage. I mean, but that’s–that’s a key part of the solution, in my mind.

EPSTEIN: Yeah, totally agree.

PERIES: All right, gentlemen, we’ll keep an eye on what’s going on, and hope you can join us next week. And we’ll do what comes out in the next few days, and give us an update. Thank you so much for joining us.

EPSTEIN: Thank you.

LASCARIS: Thank you.

PERIES: And thank you for joining us on the Real News Network.

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  1. Sound of the Suburbs

    Francis Fukuyama in 1992 said it was “the end of history”.

    The world was ready for liberal democracy as it was the only successful system and a peaceful, prosperous world lay ahead.

    A world ready for globalisation.

    A world where fair competition, free-trade and capitalism would yield the best results for all.

    Roll onto 2016 and we see a highly unstable world of massive inequality, rapidly fluctuating currencies, unstable economies and war.

    How does anyone run a multi-national business successfully in this environment, especially when the massive inequality has greatly reduced global aggregate demand?

    The original outlook missed one important factor, no one likes fair competition.

    Within nations the wealthy put in place mechanisms to ensure their children have unfair advantage. In the UK we have private schools with a sliding scale of school fees to ensure the richest parents get the greatest advantage. In the US, they have private schools and universities ensuring social stratification.

    After Brexit, we discover there was no free-trade world at all, but a world of total mistrust held together by extremely complex trade deals where nations look to gain unfair advantage in the small print.

    The globalist elite have looked to the global stage to give them unfair advantage by finding the most tax efficient places to put their and their company’s money and businesses, moving the tax burden onto others.

    Pretending Capitalism trickles down to justify low taxes on the wealthy has led to massive inequality and very subdued demand.

    The human race just doesn’t like fair competition and any ideas that it could live in a peaceful, harmonious, globalised world were always a pipe dream.

    The populists have realised elites are self-serving and unelected technocrat elites are their worst nightmare. The EU and the globalisation are never going to work.

    The elite still haven’t looked in the mirror.

    In the EU, the most powerful nation, Germany, insisted that the ECB looked after its interests.

    The Germans were the first to go bubble crazy over the boom and their version of the NASDAQ
    collapsed by 97% in the bust.

    To help Germany, the ECB lowered interest rates and blew bubbles in the Club-Med nations that burst when the Euro-zone crisis hit.

    The Euro started going wrong after a couple of years when the first bubble burst, it’s been on the way out ever since.

    Debt forgiveness, what planet are you on?
    Even within the EU, such things are unthinkable.

    To think anyone is going to work in the greater good displays a very limited knowledge of humanity.

    Not to say there aren’t good people about, there are, they are just not self-serving enough to get anywhere near the top.

  2. tegnost

    the circular logic of NPL causes banks to need bailouts so impose austerity so there are more NPL’s, but the bank, and thus the ECB (the european arm of goldman) gets the bailout. Goldman lives matter, not sure about anyone else’s…

  3. DJG

    First inaudible: “And only one bank, [inaud.] of Italy, the third-largest lender and the oldest bank in Europe, failed. All the others passed.”

    That has to be Monte di Paschi di Siena, the proximate cause of the current troubles.

  4. sunny129

    One look at the chart of Deutsche bank (DB) should tell any one, that the global banking is a big farce just like the M to model/fantasy accounting, accepted without challenge or accountability!

    I have been reading articles, commentary and analysis after analysis in various blogs and newspaper articles re how BAD is the European Banks since 2012.

    But NOTHING has materialized in terns of REALITY showing up that the ‘Emperor has no clothes’

    Everything deficiency is patched with band aid of some sort, ‘extend and pretend’ and back to everything is ‘hunky -dory”

    There is a collective cognitive dissonance out there, which every one knows but in denial and absolutely nothing done but perpetuate the myth of stability!

    Just sick of these articles!

    1. fajensen

      I am more annoyed that I keep loosing on LEAP put options on the index. Oh, well, DB is going titsup Eventually.

      1. sunny129

        Don’t short or buy PUTS on anything until Hilabama is elected in Nov. Vested interests will make sure Mkts will stay up in the stratosphere, until then.

        You cannot fight the collective insanity among CBers, out there!

  5. Edward

    I wonder if a war or some other crisis will be ginned up to distract the public from this problem? What will be the elite’s survival strategy once they can no longer “extend and pretend”?

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