Is a "bad bank" Italy's Answer to Economic Reform?

May 4, 2015Italyby Marc Chandler

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Italy's latest government's idea of a "bad bank" is controversial.

Italy's third successive unelected Prime Minister is pushing through electoral reforms that make for stronger government's going forward.  There are two elements of the reform. 

Previously, Italy was proud of its "perfect bicameralism", where Chamber of Deputies and the Senate shared power to initiate and block legislation.  The political interests of the last elected Prime Minister, Berlusconi, shaped the format.  Current Prime Minister Renzi seeks to emasculate the Senate, cutting its power to obstruct. 

The existing electoral law was ruled unconstitutional in 2013.  The grounds for the ruling was the disproportionate seats given to the winners and prevented voters from picking a preferred candidate within party lists.

The electoral reform seeks to ensure stronger governments by ensuring that the winning party has 55% of the seats (340) in the Chamber of Deputies (630 seats).  If no party wins 40% of the popular vote, a run-off of the top two parties will decide who gets the bonus seats.  There are other measures, including the strengthening of party heads in picking some candidates. Provisions to ensure better gender balance have also been included.

The electoral reform is proving controversial.  Berlusconi, who had previously supported the electoral reform efforts, has become more critical of the efforts as well as Renzi himself following the selection of Mattarella as President.  That seemed to break the cooperative spirit. 

At the same time, the left-wing of the governing PD coalition, the SEL, was also critical of the electoral reforms.  Small parties are at a disadvantage and  it concentrates the power in the party heads.  In order to secure passage of the different components of the electoral reform accepted, Renzi insisted on making them confidence votes.  This parliamentary maneuver rankles friends and adversaries and is seen as heavy-handed.

Today is the final vote in the Chamber of Deputies.  It is not a confidence vote.  However, the wrinkle is that it is a secret ballot, which may give Renzi's critics within his coalition a free-pass to reject not just abstain, as many did in the confidence votes. A failure to pass the measure would likely spark a new political crisis in Italy.  Some think that even if it does pass, President Mattarella may not sign the bill.  This seems to be a long shot.

Italy has had 63 governments over the past 69 years.  It has had four governments in the past four years.  The arcane rules were designed to prevent too strong of governments. The problem now is the opposite, too weak of governments. This is a significant obstacle to enacting the kind of economic reforms needed to modernize the Italian economy.  Italicum, as it is called, would go into effect in the middle of next year.  When it comes into effect in the middle of next year, the risks increase that Renzi seeks an electoral mandate. 

The current parliamentary session ends in 2018, but the legitimacy of the current government is debatable.  In its 2013 ruling against the existing electoral system, the Constitutional Court was clear.  The sitting parliament should remain in charge only to reform the electoral system and then is should be dissolved.  Yet, Renzi led a palace-coup against his fellow party member Letta without changing the electoral laws of holding new elections.  Renzi received a vote of confidence by a parliament that did not comply with the Constitutional Court ruling.

After electoral reform, assuming it passes, the next important legislation that Renzi seeks is to establish a so-called "bad bank" that will absorb the bad assets from Italian banks and then seek to find buyers.  This is complicated by the European Commissions’ rules on what kind of aid to banks is proper.  It envisions that the asset management company (bad bank) would buy the soured debts at market value.  The argument is that this would not count as state-aid by Brussels.  At the same time, however, the banks might not have a strong incentive to sell them if their provisions cover the mark-to-market loss.

It is hoped that the asset management company would eventually take as much as 100 bln euros in non-performing assets from the banks, which the Bank of Italy estimates to be about half of the problem.  Italy's Banking Association estimated that non-performing loans stood at 9.8% of total lending in February, the highest in almost two decades.

There may be technical reasons, relating to credit risk-weighting and liquidity issues that might provide additional incentives to get rid of non-performing loans.  In addition, to the extent that funding is tied to lending (such as under the TLTRO facility), Italian banks might still choose to pare it bad loan book.  At the same time, the prospects of an improving economy might improve the quality of some loans.  Italian banks may then choose to sell the most toxic of assets to the bad bank.

Italy: Political Reform Necessary Pre-Condition of Economic Reform is republished with permission from Marc to Market

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