The political turmoil that has gripped Rome in recent days is all too familiar for Italians. Since the second world war, the country has had a new government almost every year on average.

Italy’s banks have been gripped by perennial crisis for a good while, too. They may have been relatively unaffected by the global meltdown 10 years ago — they are principally retail and corporate lenders, with modest investment banking arms, so had put little money into the toxic US mortgage-backed securities that wreaked so much damage on European rivals. But there have been back-to-back crises ever since.

Hot on the heels of the 2008 financial crisis came the eurozone crash of 2011. The resultant Italian recession triggered mass corporate loan defaults across the banking sector. Then during 2016-17, a dozen or so troubled institutions, most notably Monte dei Paschi, the Siena-based zombie lender, collapsed and were rescued or closed down.

And now there is another, ongoing crisis. Thanks to the distractions of the preceding periods, the banks were slow to admit their shortage of capital, and have lagged behind in technology investment. The European Central Bank’s ultra-accommodative monetary policy has compounded the pressure by squeezing net interest margins.

“The business model of 99 per cent of incumbent Italian banks is not sustainable any more,” says one banking veteran. The average return on equity in the sector has barely exceeded 2 per cent for years, a long way adrift from the typical US or Asian bank and among the weakest in Europe.

Undaunted, investors seem upbeat. The Italian stock market has outperformed most others in the world this year. The 11 per cent jump in Italian bank shares over the past year has beaten many rivals. When UniCredit, Italy’s biggest bank by assets, reported first-quarter results last week, its shares popped 3 per cent, even amid broader market jitters over the Italian political situation.

The main reason for nascent optimism is the progress the banks have made reducing their vast stock of non-performing loans. UniCredit’s NPLs have fallen sharply from a peak of nearly €80bn in 2016 to €45bn now. A giant €13bn capital raising a year ago gave the bank a vital cushion to absorb losses on sales of the loans.

UniCredit’s willingness to sell an €18bn portfolio to bond group Pimco and distressed debt specialist Fortress, at just 13 per cent of face value, kick-started interest from investors in Italian NPLs as a whole. Corrado Passera, the former chief of leading lender Intesa Sanpaolo, has even set about building a new kind of bank specialised in bad loan workouts.

All the competition has helped drive up NPL prices to levels that are increasingly palatable to the banks. Most lenders have accelerated their planned sales as a result, hopeful of recouping 30 cents in the euro or more. Total NPLs peaked in 2015 at about €360bn. Excluding the less severe NPLs, classed as “unlikely to pay” loans, the core “bad loan” tally has dropped from more than €200bn a year ago to €164bn now.

Italian bank bulls also hail the progress that has been made in boosting the sector’s efficiency. Four hundred co-operative banks are currently merging to create two. And over recent years, across the private sector, the number of banks in the system has shrunk from many hundreds to just 115.

But there is still plenty left to fix. The biggest unanswered question is what happens to MPS. Having sold off most of its decent units — asset management, insurance and consumer credit — in an attempt to raise capital, it looks barely viable. Many Milan financiers expect the bank to fail at some point over the next year, forcing full nationalisation or some other form of rescue or break-up.

Even for the relatively healthy banks, there are tough times ahead. The worst of the legacy bad debts will take years to work out — notwithstanding reforms to Italy’s bankruptcy laws, seizing collateral from borrowers remains notoriously hard. Ongoing business is tough, too. As long as ECB rates stay low, profitability will be constrained even for the strongest banks. And uncertainty over the new government is a nagging hindrance, both as a likely brake on economic investment, but directly as well, amid suggestions that it could impose a bank levy as has happened in other countries such as the UK.

Italy has always been a glass half-full country. But given the banks’ remaining headaches, investors may regret toasting the sector quite so soon.

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