Bloomberg: Italy, EU can’t wait on bank reform

Bloomberg View Editorial Board

In recent years, Europe has grown accustomed to financial panic – but the latest scare wasn’t about Greece or Cyprus or Ireland. The cause for alarm was Italy’s troubled banks. In case you’d forgotten, Italy is the European Union’s fourth-biggest economy.

Europe as a whole has been slow to resolve its banking difficulties, but Italy especially so. The sudden selloff of Italian bank shares shows that decisive action on their nonperforming loans can’t wait any longer. Italy and its partners in the European Union are discussing a plan. They need to wrap up the talking and act.

There’s no longer any pretending that the issue is confined to smaller lenders, such as the four that Italy’s government rescued last November. Complacency of that sort ended when the European Central Bank asked six banks for more information. One was Banca Monte dei Paschi di Siena, Italy’s oldest and third-largest lender. Since the start of this year the bank’s market value halved before recovering somewhat toward the end of last week.

If Monte dei Paschi is an extreme case, it isn’t by much. Italy’s ratio of nonperforming loans, at 17 percent, is more than four times the European average (and Europe’s banks are in worse shape than America’s).

The answer is to create a “bad bank” to absorb these loans, so that the rest of the system can be restored to health and serve its essential purpose of lending in support of economic growth. The question is how to allocate the accumulated losses across the system’s various stakeholders.

The European Union has new rules that rightly require bank shareholders and creditors to carry much of this burden. It’s also insisting that Italy curb its public borrowing, limiting the scope for public subsidy. Italy’s prime minister, Matteo Renzi, has pushed back against some the European Commission’s demands.

A little more flexibility on both sides can bridge this gap. The EU would do well to remember that Renzi is trying, against strong domestic opposition, to be the pro-market, fiscally responsible reformer that Italy needs. In the larger task of reforming and modernizing Italy’s economy and governance, he’s the ally Europe wants.

Further delay would be dangerous. Italy has a vibrant business community and excellent long-term prospects, but an unrepaired financial system puts them in jeopardy. The last thing the rest of Europe needs is a worsening crisis in one of its largest economies, just as the EU and its central bank are struggling to revive demand and avoid the trap of deflation.
Italy and Europe need to come to terms on bank reform, and quickly.

© 2016, Bloomberg