Published June 30, 2016
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Brussels -- The European Commission on Sunday authorized Italy to use government guarantees to provide liquidity support to its banks, a spokeswoman said, disclosing the first intervention by a European Union government into its banking system following the U.K. vote to leave the EU.
The June 23 referendum sparked a steep sell-off in banking stocks followed by intense volatility this week. That has exacerbated already existing troubles in the Italian banking sector, which is suffering from high levels of bad loans and poor profitability amid super-low interest rates.
The Italian liquidity-support program includes up to EUR150 billion in government guarantees, said an EU official. Several other European countries with weak financial systems already have similar support systems in place.
The commission spokeswoman declined to comment on the amount of guarantees that were authorized, but said that the budget requested by the Italian government had been found to be proportionate. The Italian economy ministry declined to comment.
Only solvent banks would qualify for the liquidity support, which will run until the end of the year. “There is no expectation that the need to use this scheme should arise,” the commission spokeswoman said.
The guarantees, which could be used to guarantee debt issued by banks, are separate from an Italian government blueprint to recapitalize weak lenders. Italian officials have said that the government hopes to inject up to EUR40 billion in fresh capital into domestic banks.
In contrast to liquidity support, which the commission can approve during times of market turmoil, capital injections fall under the EU’s new strict rules on bank bailouts. Those rules would require private investors, including bondholders, in the bailed-out bank to take losses.
“As this decision and other precedents demonstrate there are a number of solutions that can be put in place in full compliance with EU rules to address market turbulence,” the commission spokeswoman said. She said the support program was approved under the commission’s “extraordinary crisis rules for state aid to banks,” and that guarantee programs such as the one for Italy were generally approved for six months so they could be adjusted for new developments.
Diego Valiante, head of the financial-markets and institutions unit at the Centre for European Policy Studies, said the decision to allow extra support was a clear reaction to the market turbulence that has followed the Brexit vote.
“This is good news for the Italian banks,” he said, adding that similar programs could be set up for other countries with battered financial systems.
The victory of the “Leave” vote in the British referendum has triggered political turmoil in the U.K., where Prime Minister David Cameron has said he would step down after the summer. Questions remain about when—and if—a new government will trigger formal exit talks with the EU and what kind of relationship it would seek with the bloc.
“There will be a long period of uncertainty around this,” he said.
The post-referendum market moves have exacerbated preexisting problems in the Italian banking system, even though banks in other countries, such as Spain, have a bigger exposure to the U.K. market and have seen their shares drop even more.
Italian banks have lost more than half of their market capitalization since the beginning of the year, as investors fret about some EUR360 billion in bad loans still logged on their balance sheets. That drop in market value compares to an average decline of less than one third for European lenders.
Some Italian banks have seen their shares plummet by some 75% in the first half of the year.
A person familiar with the Italian government’s plans said the cabinet of Prime Minister Matteo Renzi hoped to use a liquidity backstop to contain investor panic, which could result in a run on deposit and affect banks’ liquidity.
The liquidity support provides a temporary cushion for Italian banks. But it doesn’t solve the broader issue of how to raise sufficient capital to sustain writedowns of loan portfolios gone bad.
The commission’s decision also comes ahead of several important supervisory announcements for European banks. The European Banking Authority will publish the results of its latest stress tests by the end of July. Although these stress tests aren’t designed to fail specific lenders, the European Central Bank could ask banks to raise more capital in their wake.
Later this summer, the ECB plans to publish draft guidance on how banks should deal with nonperforming loans, or NPLs.
Re-disseminated by The Asian Banker from The Wall Street Journal