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Finally Time to Fix Italy’s Banks?

Nicolas Véron says the results of Italy’s referendum leave the country’s shaky banks in limbo for now but could pave the way for a government that is better positioned to push through painful reforms.
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Unedited transcript

Pedro da Costa:  I'm Pedro Da Costa and this is Peterson Perspectives. Now that Italians have soundly defeated Prime Minister Matteo Renzi's referendum. What does this mean for Italian banks? I'm joined by Nicolas Véron, senior fellow here and an expert on European banking affairs. Thanks for joining me.

Nicolas Véron: Thanks for having me.

Pedro da Costa: So the Italian referendum was seen as this kind of next domino on this wave of nationalist populist events that started with Brexit and then followed up with the election of Donald Trump. Was that an overstatement of how significant an event it was?

Nicolas Véron: I think it really depends how you look at it. This was a domestic vote on a domestic matter, a political matter. It was not about a relationship with the European Union, the membership of the Eurozone, not even remotely or indirectly.

So in domestic political terms, this is a big event, the end of the Renzi government. Mr. Renzi will probably stay in politics, but he's soundly defeated as you said. And there is a lot of popular resentment against elites. Renzi was initially a candidate against elite, but he's seen widely as having been corrupted by them.

So you have all these dimension and indeed, it's not unlike what we've seen in other places. At the same time, there has been a lot of comment both inside and outside of Italy to picture this as framing it in an EU frame of reference, but that's not what it is at all.

Pedro da Costa: There wasn't a pro-European or anti-European vote.

Nicolas Véron: No. And actually when you look at the analysis of the vote. You see that you have pro-Europeans and anti-Europeans among those who voted both yes and no. Certainly, many divided views inside the majority no camp. Also, the pattern of vote is very different from Brexit and Trump. For example, the young voted overwhelmingly against the referendum proposals. So you don't have the same pattern of the old people voting against the mainstream and the young voting for their future as you saw in the UK or the US.

So I think it has to be taken into a very idiosyncratic context of Italian politics. Certainly, a significant event domestically. Not necessarily very significant from an international or European perspective.

Pedro da Costa: Now, when you look at the banks, of course the banking crisis kind of existed before the vote and it's going to continue on afterwards. What does difference does it make that Matteo Renzi was defeated and what kind of a government are we going to get and what are the implications there?

Nicolas Véron: I think it's a bit early of course to know, A, which government will emerge in Italy and, B, what will be the direction of travel for its banking system. But what is clear is, that there had been a bit of a frozen situation in Italy as far as the banking system is concerned. There was an unwillingness to do what has to be done in terms of closing banks and restructuring of the sector, certainly this last six months, if not more. And also from the EU authorities starting with the European Central Bank, which supervises all the banks in the Eurozone now.

So the mere fact that the referendum is now past, almost irrespective of the result, means that there will probably be some action in the Italian banking sector. Actually, we've already started seeing that the CEO of medium-sized banks in trouble, Banca Popolare di Vicenza, has resigned this morning. And so we'll probably see some reasonably fast moving development in the Italian banking system, perhaps not in the next few days, but probably in the next few weeks.

And frankly, this is a national banking sector where reform and restructuring is long overdue. It has been in a state of systemic fragility for certainly more than two years now and it's high time for a more forceful supervisory and restructuring action in the Italian banking sector.

Pedro da Costa: Can you explain to our viewers and listeners why it's been so difficult? What the dynamic is with retail owners of bank bonds and how that all developed in the context of European banking reform that you've written so much about?

Nicolas Véron: Yeah. Italy has a very large banking sector, very fragmented, lots of small banks, local banks, which have a lot of political connections for better or worse, so lots of local lending to local businesses. This makes it highly sensitive from a political standpoint and also many banks as you hinted at, has been selling their own bonds including junior bonds, including actually shares to their retail customers, with practices which frankly aren't very best in class, if you will, in terms of serving the customers and aligning with the interest of the customers.

So whether it's fraud or mis-selling, it remains to be established by the relevant jurisdictions, but certainly there had been very questionable commercial practices from the banks and the result of that is that many retail households own large amounts of shares, junior debt and senior debt of many banks some of which are in trouble. So that makes the resolution of the problem in the Italian banking sector more difficult politically, certainly in other places.

Now the EU institutions are very aware of this, and there are a lot of discussions going on, on how the retail victims of mis-selling should be protected and possibly compensated or indemnified for losses, but that shouldn't be a free for all. That shouldn't extend to professional investors, institution investors, wealthy individuals, et cetera. So there's a big negotiation going on, on what could be the conditions, the right conditions for a restructuring of Italian banks including possibly Monte dei Paschi di Siena going forward.

Personally, I expect this discussion to make a lot of progress in the next few weeks and I think we could see some long overdue restructuring action.

Pedro da Costa: You said that -- you mentioned earlier that Renzi's departure might actually pave the way for some optimism in that.

Nicolas Véron: Well, in way, that's sad statement to make, but I think indeed certainly during the referendum campaign and in the last at least six to nine months, the Renzi government has acted more as a break on the overdue restructuring of the banking sector than as a promoter of it. And, again, for entirely understandable political reasons, but which have not necessarily served the country very well, because we know from past experience of other systemic banking crisis, for example in Spain and not very far from Italy, but also in many other countries including Japan, [inaudible 00:06:52.0] and others, that the longer you wait to address this sort of situation of system-wide fragility, the higher the final bill, so inaction.

This problem is not going away. Inaction is not the way to go to address it. And I think even though it will painful, it's long overdue that there would be more activity in terms of bringing the Italian banking sector back to health. It also becomes frankly, a credibility issue for the European Central Bank, which has been supervising Italian banks for more than two years now and faces a lot of questions about the soundness of the system.

So it's not an easy, again, I don't think it's an easy statement to make, but it could be the case that the more caretaker technocratic government would be politically in a better position to do, if you will, what it has to do in terms of the Italian banking system, as the Renzi government has been, certainly in the last 12, 18 months.

Pedro da Costa: So the good old zombie bank problem that so many countries have had so much trouble slaying.

Nicolas Véron: I think Italy meets the textbook definition of a zombie banking system or certainly has done so in recent past. And it's important indeed to kill the zombies to save the living creatures. So we'll all be watching this very attentively.  

Pedro da Costa: Thank you so much for your time.

Nicolas Véron: Thanks again to you.