Italian vote sheds no light on NPLs but politicians will keep muddling on

Rarely a week goes by without the Italian banking system cropping up directly or indirectly in the discourse of a distinguished European policymaker. Whether the discussion is non-performing loans or the need for consolidation, the Boot finds itself in the crosshairs.

Investors are also watching closely. Ahead of the election, Bridgewater has implemented large short positions against Italian banks — at one point amounting to a $770m bet against financial stocks, according to Bloomberg. However, Italian equity and credit has remained relatively stable in the run-up to the vote.

The subject of the banking system has remained largely off the table in the heated general election campaign, which pits a right-wing coalition, consisting of Silvio Berlusconi’s centre-right Forza Italia and Matteo Salvini’s far-right Northern League, against Beppe Grillo’s Five Star Movement and Matteo Renzi’s centre-left Democratic Party.

Topics such as immigration and taxes have taken centre stage instead — perhaps partly as banks are such an emotive issue in this country of savers.

“You will never hear anything on banks during the campaign because nobody even dares to touch the issue,” said Carlo Alberto Carnevale Maffè, professor of strategy and entrepreneurship at the SDA Bocconi School of Management.

While it is the European authorities who put in place much of the key regulatory framework for large Italian banks, including how they must provision for their non-performing loans and what happens when they are declared failing or likely to fail, Italian bodies have several key levers available to them and the next administration must decide whether to continue with the policies enacted by the current centre-left administration.

First, authorities must decide whether to extend the GACS scheme beyond 2018. This scheme gives a state guarantee for the senior tranche of NPL securitizations. Since being introduced in August 2016, banks including UniCredit and Banca Carige have made use of it to dispose of NPLs.

Second, and more tricky, is deciding whether to reform the legal system in the interests of creditors. Banks and NPL investors hoping to reclaim assets must go through a notoriously slow judicial process, and this is seen as a big hindrance in reducing levels of bad liabilities in the financial system. But making it easier to repossess property will be politically sensitive.

This is particularly the case since many NPLs are backed by real estate. Accelerating their recovery could hurt property prices, damaging the value of existing assets and the liquidity of the market, according to Carnevale Maffè.

“It’s not an easy problem to be solved, and that’s why most of the discussion has been postponed until after the election,” Carnevale Maffè said.

Third is deciding what to do in individual cases of struggling banks where the state can intervene without breaking European rules. Italian authorities have continued to prove adept at manoeuvring around such rules to pump money into the sector.

Last year, the Single Resolution Board said Veneto Banca and Banca Popolare di Vicenza were declared as not sufficiently significant to require resolution action, meaning they were liquidated under Italian law. Good assets and senior liabilities were transferred to Intesa Sanpaolo, with the help of state guarantees and cash injections.

Monte dei Paschi di Siena met the conditions for a precautionary recapitalisation in July, allowing the Italian state to put in money.

“I think there is a broad consensus in Italy that they should use public money as much as possible within the constraints set by European authorities: BRRD [the bank recovery and resolution directive] and DG Comp [the European Commission’s department for competition policy],” said Nicolas Véron, a senior fellow at Bruegel.

“I think the political developments are very second order compared with that consensus.”

Fourth, the new administration must oversee the implementation of legislation introduced by Renzi in 2016, which obliges Italy’s small co-operative banks to come under a holding company with at least €1bn of equity by May. This is another potential headache.

The banks will probably merge into two or three large groups at a national level. High levels of NPLs are thought to lurk on the balance sheets of these small banks, and this could come under sharper focus as the larger entities come under ECB supervision: Cassa Centrale Banca and Iccrea will undergo asset checks this year. But any losses incurred by investors as small banks merge could be toxic politically.

“There will be a revolt at the local level against the possible process of consolidation that may require some sort of burden sharing, a consolidation of bank bonds into equity,” said Carnevale Maffè.

That politicians have avoided these issues in the campaign could be seen as bringing considerable uncertainty for market participants. But consistency should be expected, if only because no strong administration is likely to emerge from the elections.

Observers either expect victory for the right-wing coalition — with Forza Italia and the Northern League vying for internal supremacy — or no grouping achieving overall control in parliament. The latter scenario would result in a grand coalition or new elections.

Even if a new administration would like to change direction, its capacity is likely to be limited by a fractured parliament. “There is no centre of gravity here,” said Carnevale Maffè.

And despite creeping Euroscepticism among parties and sections of the electorate, pro-European sentiment in Italy’s establishment could keep policy largely consistent. “Bureaucracy is the real guarantee that Italy will stick to the European pack,” Carnevale Maffè added.

The “black swan” event would be the Five Star Movement entering government, either alone or in tandem with the Northern League. Observers believe the chances of this are very limited, although it is worth noting no polls are published in the last two weeks of campaigning and at the last count more than a third of voters remained undecided.

Would a Five Star Movement administration treat Italian banks any differently? Luigi Di Maio, leader of the Five Star Movement, did tell Bloomberg Television: “We must shorten the time it takes to recover [NPLs] by eliminating a series of Byzantine laws”. But the movement’s founder, Beppe Grillo, has been a vocal critic of the banking system.

“There’s a lot of nonsense being spoken [by the Five Star Movement] but there are also a lot of ideas that are disruptive in a good way and that would represent meaningful reform in Italy,” said Véron.