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The fight against the Corona crisis should increase Italy’s debt to more than 2.5 billion euros. A possible failure would ruin national banks and insurance companies.
The Italian government is slowly loosening the restrictions. However, Italy’s economy is likely to collapse nearly a tenth in 2020 and debt will rise to 159% of gross domestic product.
Italy’s mountain of debt was dangerously high even before the corona virus crisis. Financial aid now allows you to keep growing. At the end of 2019, before the plague broke out in Europe, Rome’s commitments totaled 2.41 billion euros. That was almost a quarter of public debt in the euro zone.
As a reminder: in the 2010 crisis, the EU resisted Greece being crushed by its mountain of debt and becoming insolvent and having to give up the euro. Athens’ debt represented 179% of gross domestic product (GDP) at the end of December. This is the highest figure in the EU, ahead of Italy (135%). But the absolute numbers show that the insolvency of the third largest economy in continental Europe is a much bigger problem for Europe than Greece in the euro crisis. And it keeps getting worse.
In its spring forecast, the EU Commission anticipates that Italy’s economic output will decrease by almost a tenth in 2020 and that debt will increase to 159% of GDP. That would be around € 160 billion in additional debt. Ratings agency Fitch recently downgraded the country’s credit rating to “BBB–”. This is one step from the waste state, in which certain institutional investors can no longer invest. There is a risk that Italy can no longer pay the debts. But: Who would suffer if Rome stopped paying?
Who owns the Italian debt?
Italy’s debt is primarily an Italian problem. That shows the figures of the central bank, the Banca d’Italia. At the end of January, national investors had around two thirds of € 2.444 billion debt.
A haircut would initially affect Italy, with disastrous consequences. Because figuratively speaking, Bel Paese’s biggest creditors, banks and insurance companies, are actually beggars. If they had to cancel their demands, they would face serious problems themselves.
Banks are already in trouble
Italian banks are by far the largest lenders in their country. By the end of January, they had borrowed € 639 billion. 59% of these are government bonds, the rest are loans. The twelve largest banks in Italy, supervised by the European Central Bank (ECB), had Italian government bonds worth € 264 billion at the end of 2019, but only € 152 billion of fixed capital (CET1). A 60% haircut would destroy it. And as if that wasn’t enough, these banks still had bad loans of € 117 billion at the end of December. If amortizations are required, the capital required for the course of business melts. The industry cannot afford to default on bonds.
The German Institute for Economic Research (DIW) wrote in April that even ten years after the financial crisis, Europe’s banks and states were still interdependent. German Finance Minister Olaf Scholz last requested in December that government bonds be deposited with capital in the euro zone. But Rome does not like that. National banks would have to raise a lot of capital for this. According to DIW, it would be around 9.6 billion euros according to 2018 figures.
Insurance companies would also be kneeling
Insurance companies could be further affected. National “financial institutions”, mainly insurance and investment funds, had Italian government bonds of € 458 billion at the end of January. Figures from the European supervisory authority Eiopa show that in late September, Italian insurance companies reported that they held € 349 billion of national government bonds. At the same time, they had 112 billion euros in capital. A haircut of only a third would destroy it.
By far the largest Italian insurance company, Generali, had invested € 63 billion in Italian government bonds at the end of last year and had equity of € 30 billion. The situation is extreme at the Italian Post, most of which is controlled by the state. He had Italian government bonds worth € 143 billion at the end of December. Of these, 105 billion euros were on the books of the life insurance subsidiary Poste Vita. However, the entire group only had a net worth of € 9.7 billion at the same time.
The industry’s strong focus on national government bonds also has to do with the fact that certain products are tied to government bond yields. Consequently, companies buy them for their protection. If the status is not predetermined as a debtor, this is not a problem. A haircut would have disastrous consequences.
The central bank is also not a friendly debtor
Banca d’Italia itself had 408 billion euros in national government bonds at the end of January. Analysts’ estimates from Bank Unicredit suggest that € 85 billion of this relates to its own investment portfolio. There are also securities that the central bank acquired as part of the ECB’s bond purchases. Most of it (estimated at € 320 billion) is part of the Public Sector Purchase Program (PSPP) recently denounced by the Federal Constitutional Court of Germany.
These promissory notes are with Banca d’Italia because the expression “The ECB buys bonds” is imprecise. Strictly speaking, the ECB has been buying the bonds together with the 19 national central banks of the euro countries since 2010. The group is called the euro system and is generally based on the distribution of purchases based on the respective share in the ECB. That is 17% for Italy. This key is intended to ensure that liquidity benefits everyone equally. Basically, each National Bank buys government bonds from its own country. At the end of April, the euro system had values worth 2,822 million euros, some of which were in Banca d’Italia. PEPP’s pandemic program also continually adds more titles.
This leads to another problem, which economist Daniel Gros described in a publication by the Brussels Ceps expert group in mid-2019. First of all, Banca d’Italia risks default on the bonds themselves. Gros believes that the central bank of Italy should, in principle, be consolidated with the public budget. Consequently, the government debt and the assets of the Banca d’Italia of households would cancel each other out. But then the corresponding liabilities of Banca d’Italia would be added to the Italian debt. However, these are high, also because the central bank acquired the papers mainly through the ECB’s Target-2 clearing system in other euro area countries. In simple terms, Banca d’Italia had the purchase amount written to the ECB instead of transferring it.
For some time now Target-2 has been a topic of conversation especially among economists in Germany. That has to do with balances. The Deutsche Bundesbank had a Target 2 loan of € 935 billion at the end of March, while the Banca d’Italia had a loan of € 492 billion. However, this compensation system basically does not provide debt relief.
France is particularly at risk in Europe
Investment companies (approximately estimated at the end of January: € 100 billion) and households (€ 157 billion) and foreign investors (€ 782 billion) remain in Italy. However, some of the bondholders outside Italy are likely to be Luxembourg funds, whose ultimate beneficiaries are themselves Italians.
It is not easy to determine who exactly are the foreign investors. Unicredit analysts arrived at the following breakdown in April 2019 based on 2018 data. Accordingly, foreign central banks and other banks each had 19%, the ECB 8%, and insurance companies, investment companies and households 53%. At 78%, the vast majority of Italian debt held outside Italy was in the euro zone. That would have been 610 billion euros at the end of January, more than the GDP of the nine smallest euro area economies combined. Broken down by country, 21% of the bonds were in France, 14% in Germany and 14% in Luxembourg.
If you look at the situation more generally, that is, in terms of how much money foreign banks have lent to the state, businesses and households in Italy, it is clear that France is particularly exposed. According to figures from the Bank for International Settlements (BIS), French money houses had claims against Italian debtors of € 286 billion at the end of 2019. All foreign banks registered by the BIS worldwide borrowed from Italy a total of € 707 billion. In the euro area, France and Spain are behind France and Germany with € 74 billion each.
At the end of June 2019, according to the European banking regulator, the large French bank BNP Paribas owned Italian government bonds worth 26 billion euros and had a net worth (CET1) of 80 billion euros. That is better than Italian banks. But an impediment would still be uncomfortable.
The public investor replaces the private creditors.
In the event of a haircut, most foreign investors, in addition to Italian homes and investment firms, are less protected than other creditors, economist Gros concludes. The Italian state would probably like to save national banks and insurance companies, or, as it happened in Greece, otherwise it would simply be called to bail out the banks. Banca d’Italia’s debt to the ECB, on the other hand, can hardly be touched as long as Italy wants to keep the euro.
This mainly leaves foreign investors and Italian homes. In the event of a haircut, your claims are particularly at risk. Therefore, it is not surprising that these creditor groups have significantly reduced their share of Italian government debt since 2009. The Banca d’Italia and, therefore, the ECB’s euro system are increasingly taking their place. .
