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Italy: Crisis? What crisis?

Bernd Riegert | Nils Zimmermann
March 2, 2018

Italy's banks struggle with bad loans and the state itself is saddled with massive debt — but the voters don't seem to care, and the finance minister is demonstratively relaxed about it all.

Italien Wahlkampf 2018 | Stammhaus der Bank Monte dei Paschi in Siena
Image: picture alliance/Arco Images/F. Schneider

The Tuscan hill town of Siena is more ancient than Rome. It was an old Etruscan village by the name of Saena back when the Seven Hills of the Eternal City were nothing more than wilderness. Fitting then that Siena is home to the headquarters of the oldest continuously operating bank in the world: Banca Monte dei Paschi di Siena (pictured above). Literally, the bank's name translates to "mountain of pastures of Siena," though figuratively, Monte can mean "a pool of assets." Pastures were important assets used as collateral in early Italian banking.

It was in northern Italy that modern banking's core tool arose: double-entry bookkeeping. Double-entry accounts showing assets and liabilities in two parallel columns of figures, both of which had to add up to the same sum under the bottom line, were popularized as the "Venetian method" by the Tuscan-born mathematician Luca Pacioli. Pacioli, a Franciscan friar, wrote the first standard accounting methods textbook for use by merchants and bankers, based on methods that had arisen in the region in the late Middle Ages. 

Mountain of pastures, mountain of debt

Given that deep history, no one could accuse Italy's financiers of inexperience. Yet in 2016, Monte dei Paschi, as the Siena bank is generally known, was at the brink of having to file for bankruptcy, because its balance sheet was jammed with dodgy assets — loans the bank had made to borrowers that were in arrears, and at risk either of not being repaid in full, or not being repaid at all. The same was true of several other major Italian banks.

Many Italian borrowers, including many small and medium-sized enterprises, have been in arrears on their bank loan repayments in recent years. Two-thirds of the bad debt, as of May 2016, was in the construction and real estate sectors — because with unemployment high and economic growth absent, the demand for new buildings has stagnated.

The amount of gross non-performing loans clogging banks' balance sheets nearly doubled in the five years to 2015, reaching €360 billion ($439 billion), or 18 percent of total loan value. With so many loans in arrears and the country's GDP stagnant, banks were reluctant to make new loans, starving Italian businesses of money needed to upgrade or expand. Something had to be done.

The Piazza del Campo, at the center of Siena's old townImage: cc-by-sa/Massimo Catarinella

Root problems

Over the past decade or more, wide swaths of Italian industry have become uncompetitive on global markets, which are ever more flooded with high-quality, low-cost goods produced in Asia, the Americas, or elsewhere in Europe.

Italy, with relatively high wages and other costs and an inflexible, excessive bureaucracy, is not a low-cost production location. In past decades, before it adopted the euro in 2002, Italy was able to compensate for this by devaluing its previous currency, the lira. But now, yoked as it is to the euro — which is among the hardest of hard currencies — the devaluation gambit is no longer available. Painful internal adjustment of euro-denominated wages and prices are the only way for the country's businesses to regain competitiveness.

Cleaning up balance sheets

Since 2016, increasing efforts have been made to clean up the balance sheets of Italian banks. Monte dei Paschi, Italy's third-largest bank, wrote off some of its bad debts and went on a cost-cutting spree, closing branches and laying off employees. It was rescued by a recapitalization in the form of a nearly €4-billion cash injection from the Italian state, which is now the bank's main shareholder.

Other banks have made similar efforts to reduce the mountain of distressed loans on their books, and have raised new capital from investors, including the Italian state, to avoid bankruptcy. The estimated size of that mountain of bad debt has declined from its 2015 peak of around €360 billion, down to about €64 billion now.

Siena, the epicenter, is the finance minister's turf

Pier Carlo Padoan, a former IMF and OECD economist and professor of economics, became Italy's finance minister in February 2014. He has since been responsible for coordinating the state's efforts to manage the country's banking crisis. Padoan recently joined Italy's Social Democratic Party, for which he is running as a candidate in this weekend's national election. His electoral district: Siena.

Infografik Italien vor und nach der Finanzkrise ENG

In Padoan's view, Italy's banking crisis is essentially over. "The story of the bad debts is trending toward a happy end. The bad-debt rate has fallen by 25 percent since a year ago, in part because of the measures taken by the government. I don't see a banking crisis in Italy at the moment," he told DW in an interview.

Padoan's view may be optimistic. A few weeks ago, Genoa's Banca Carige became the latest Italian bank to barely avoid having to admit bankruptcy.

Banks play no role in the election campaign

Economics professor Ruggero Bertelli of the University of Siena is not happy about the fact that the state of the country's banks is playing next to no role in the national election campaign discourse. The country has returned to economic growth, albeit at a modest pace, with GDP up about 1.6 percent in the last quarter of 2017 compared with a year earlier.

As a result, the state of Italy's banking sector is less of an issue than it might otherwise have been. But although Monte dei Paschi and other banks, post-rescue, are currently solvent again, there remain serious structural issues to address, Ruggero told DW: "There are far too many small banks. They must consolidate through mergers, and many bank branches must be closed in order to reduce costs."

In his election campaign in Tuscany, Pier Carlo Padoan was facing off against the populist Cinque Strelle party, the Five Star Movement. The man the Five Star party considers its in-house finance expert is Leonardo Franci. Franci contests the finance minister's optimism, saying: "the banks' bad-debt problem is not yet solved." He claims the balance sheets of the banks are being doctored to look better than they really are, and says "we need a European solution for the problem."

Claudio Borghi, the candidate for Lega Nord, a populist party of the center-right coalition contesting the election, in Siena's electoral district, proposed a more radical solution. He would nationalize Banca Monte di Paschi di Siena entirely, and force it to make more loans to small businesses. "The leftists have destroyed the oldest bank in the world, and now they claim they've saved it," he said.

Italian Finance Minister Pier Carlo Padoan
Italian Finance Minister Pier Carlo Padoan, an experienced economist, has managed the enormous job of getting the country's banks back on the path to solvency since early 2014Image: picture-alliance/dpa/AP Photo/V. Wijngaert

Italy's state debt

Another issue for Italy's economy is that the cumulative debt of the national government is rather high. In 2016, it amounted to a sum equivalent to 132 percent of the country's GDP. By comparison, in 2016 the number for Spain was 99 percent, and for Germany 68 percent. The eurozone has adopted a target of 60 percent for member nations' debt-to-GDP ratios, though the basis in macroeconomic theory for this, or any other specific target ratio, is hotly contested amongst economists.

All of Italy's main political parties say the national debt should be reduced, and most propose expenditure reductions, but the details remain vague, says economist Ruggero Bertelli. There is agreement, however, that increasing the vigor of the domestic economy is important. In Leonardo Franci's view: "Italy is actually rich. We have many prosperous families. We need to reduce [state] expenditures and increase domestic demand."

In regards to the state debt, finance minister Padoan is as calm as he is about the state of the banks. He doesn't see a crisis in either domain: "The claim that Italy will explode is something I've heard many times in my long career — it has never happened.

Italian goverment saves Monte dei Paschi

Bernd Riegert
Bernd Riegert Senior European correspondent in Brussels with a focus on people and politics in the European Union