In the aftermath of the UK’s vote to leave the European Union, Italy is the latest European nation to come under the spotlight.
The country’s financial sector is on the brink of collapse, and a referendum on constitutional reforms in October has the potential to topple prime minister Matteo Renzi’s government and cause an unprecedented political crisis.
All of this has increased speculation that Italy could be the country to provoke the eventual collapse of the European Project.
Obviously, this is an outcome that no-one — particularly European banks themselves — wants. As a result analysts and strategists across the continent are scrabbling to find a solution to Italy’s problems. Analysts at Deutsche Bank Research have been particularly busy.
In the bank’s latest 37-page long Focus Europe note, Deutsche analysts, led by chief economist Mark Wall, put forward a six-step plan that they believe will help Europe’s banking and financial sector weather the current storm. The plan provides an excellent summary of all the biggest problems facing European banking, and provides some solutions to those problems. Here’s Deutsche’s so-called “wish list” for the European finance sector:
- Injecting around €28 billion of capital into Italian banks to help deal with the country’s problem with non-performing loans. Deutsche argues that the NPLs should be imposed on the markets at market price with no discount.
- Both state-aid and bail-in rules should be suspended by the ECB when necessary, allowing bailouts to be carried out during “a serious economic disturbance” like the one going on right now.
- Allow recapitalisation of banks from a federal level, ideally from the European Stability Mechanism, the EU-wide organisation tasked with crisis resolution and providing emergency loans. However, Deutsche Bank acknowledges that recapitalisations may have to come at a national level thanks to the clear “legal and political constraints.”
- Deutsche argues that the acceleration of the Europe-wide banking union, to include a euro-area wide deposit insurance scheme, could help ensure stability. The eurozone banking union came into existence in 2012, and currently includes two key schemes, the Single Supervisory Mechanism, and the Single Resolution Mechanism.
- The ECB should resist implementing any more capital tightening measures. It is currently implied that capital controls will increase by around 1% by 2019.
- Finally, Deutsche Bank argues that the ECB should resist further cuts in its base deposit rate — currently at -0.4% — and be more flexible in terms of monetary policy. “A further rate cut would have very limited effects on the exchange rate while further damaging the banking system,” Deutsche notes.
Deutsche concludes by saying (emphasis ours):
“We put forward a wish-list that would strengthen the stability of the Italian and European banking system. This would be a fundamental benefit for the whole euro area while facing Brexit’s prolonged uncertainty. Countries’ divergent short-term political interests as well as regulatory and legal constraints represent a major hurdle to preventing financial instability.”
It should be noted that Deutsche Bank has recently been high critical of the powers that be in Europe, saying in early June that ECB policy could have catastrophic consequences and that it “is threatening the European project as a whole for the sake of short-term financial stability.”
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