Italian banks’ bad loans need long-term solution: rating agency

Italian banks’ bad loans are holding back its economy, but creating a “bad bank” and dumping them there is not a good idea, because deeper reforms are needed, a European rating agency has warned.

The Italian government is in talks with the European Union on whether creating a bad bank for non-performing loans at its biggest banks would represent state aid.

The bad bank would take around 100 billion euros ($112 billion), or about one third of Italian banks’ bad loans, were it to go ahead.

The move would be credit-positive for the banks, but it would worsen government finances, because it would shift the issue away from the private sector to the public sector, Marco Troiano, an analyst with European rating agency Scope Ratings, said in a recent report on Italian banks.

Besides raising issues with the EU as it could be conflicting with rules on state aid, it would also be unpopular at home as it would be seen as a taxpayer bailout for the banks.

Creating a bad bank would not tackle the underlying reasons for Italian banks’ non-performing loans (NPLs), which were higher than in the rest of developed Europe even before the financial crisis hit, Troiano argued in his report.

Instead, the Italian government should look into reforming the judiciary to speed up the resolution of bankruptcies as a long-term solution for lowering bad loans in the Italian banking system.

“Improving the efficiency of the judiciary would improve the ultimate realisation value of NPLs, by reducing related insolvency fees and the cost of carrying the assets for several years before being allowed to seize the collateral,” the Scope Ratings analyst said.

Italian banks' bad loans and its judiciary

Italian banks’ bad loans resolution impeded by ‘byzantine’ judiciary. Source: Scope Ratings

Scope Ratings has calculated that there are 34 lawyers for every judge in Italy, compared with 26 in Spain, 14 in Portugal and 11 in Greece. This is “evidence of a byzantine legal system that is hard to navigate,” in Troiano’s words.

Italy also has fewer judges per head than many other countries in the rest of Europe, and this shortage of judges adds to the backlog of pending cases.

There are currently five pending litigation cases per 100 inhabitants in Italy, compared with a little over three for Portugal, under three for Spain and two for France.

In Germany, Austria and Sweden there is less than one case of pending litigation per 100 inhabitants.

Italy is overtaken only by Greece, with more than five cases pending.

Looking at the length of resolving insolvency, it is roughly in line with that in France in Portugal, at 1.8 years in average, but longer than in many other countries.

The comparison of the estimated cost of resolving bankruptcy is “even more eye-popping,” Troiano noted.

“Here, Italy is a true outlier among European countries. The cost of insolvency amounts on average to 22% of the insolvency estate, double the percentage it is in Spain, and three times that of Germany,” he said in the report.

Encouraging out-of-court settlements for minor claims, increasing investment in the digitalisation of various processes to do with the non-performing loans, as well as removing fiscal barriers from banks looking to make loan loss provisions are among the main suggestions Scope Ratings made for a sustainable, long-term reduction in Italian banks’ bad loans.