Non-Performing Loans Hurt Efforts of Italian Banks to Increase Capital Levels

on Jun 20, 2012
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Despite the pledge of the leaders of the Group of 20 (G-20) in Mexico to deal with Europe’s debt crisis, the situation in Italy seems to be getting worse by the day. On 20 June 2012, Bloomberg reported that the waning loan quality was hurting efforts of Italian banks to increase their capital levels in the midst of the country’s third recession in a decade and the ongoing Eurozone crisis.

Bloomberg quotes Bank of Italy data showing that in April 2012, the Italian corporate and household debt increased with 15 percent relative to a year earlier, reaching €109 billion. Non-performing loans as a proportion of total lending reached 5.4 percent in March, up from 3 percent in June 2008, according to data of the Italian Banking Association.

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!m[](/uploads/story/132/thumbs/pic1_inline.png)Europe’s debt crisis has contributed to Italy’s austerity-induced recession, with Mario Monti’s administration pushing through measures such as higher taxes and a rise in pension ages. According to a recent article in the Financial Times, Italy’s economy contracted 0.8 percent in the first quarter of 2012, shrinking 1.4 percent year on year. FT notes that Mr Monti’s government is hoping to raise €10 billion through asset sales and save another €5 billion by spending cuts, and yet, that might not be enough so as to offset the need for increasing taxes even further if the budget deficit target of 1.7 percent is to be achieved.

As may be expected, the recession reduces the ability of Italian borrowers to pay their bank loans back, meaning that banks need to increase their reserves for non-performing loans. The unemployment rate in the country, which reached 10.2 percent in April, is the highest in almost twelve years, making it harder for Italian companies and families to repay their debts and find new credit.

Bloomberg notes that in May, Moody’s Investors Service downgraded 26 Italian banks on account of weakened earnings and the poor economic outlook. In its May report, Moody’s noted that the growth in non-performing loans would “increase non-earning assets and likely keep loan-loss provisioning needs high”. Bloomberg also reports that brokers such as Nomura Holdings Inc. and Keefe, Bruyette & Woods Inc. cut their forecasts for the 2012 earnings of Italian banks. According to data compiled by Bloomberg, analysts have lowered their earnings-per-share estimates for Italy’s 13 biggest banks by 17 percent on average since the beginning of 2012.

Bloomberg reports that Italian banks have already borrowed more than €255 billion from the European Central Bank (ECB), with the funds being invested in short-term government bonds offering high yields. Pedro Fonseca, analyst at Berenberg Bank, notes that if capital flight is not reversed, this trend is likely to continue, and “the banks’ reliance on central funding will have to increase”. Yet, as quoted by Bloomberg, he estimates the risk of an Italian default as being remote and notes that “the banks’ funding pressures are manageable”.

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