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Banks

Pressure mounts on Italy's Renzi to strike EU deal on 'bad bank'

ROME (Reuters) - Italian Prime Minister Matteo Renzi has set himself up as a man who does not like to compromise, but he needs to reach a deal quickly to stop Italy’s banks sinking under the weight of bad debts which are stifling a fledgling economic recovery.

Italy’s lenders hold 201 billion euros ($220 billion) in non-performing loans (NPLs) which grew during the recent three-year recession and are clogging the system, slowing the release of new credit that the economy badly needs.

Besides the NPLs, which are loans in default and highly unlikely to be repaid in full, the Bank of Italy says there are a further 160 billion euros of problematic debt that could become NPLs. Taken together, these doubtful loans represent around 22 percent of Italy’s annual gross domestic product.

Unnerved by the growing weight of bad debts, investors - already rattled about global economic growth - have been off-loading Italian banking stocks over the past week. They have focused especially on the most vulnerable lenders, including Monte dei Paschi, Italy’s third-largest bank, which has lost 40 percent of its value this month.

It sent alarm bells ringing in Rome and Brussels, which both want to avert the possibility of a failing Italian economy that could weigh down the euro zone, but have struggled to find a solution after almost a year of fruitless discussions.

Other European countries like Spain and Ireland moved swiftly in the wake of the financial crisis to set up special asset management vehicles - so-called “bad banks” - designed to take soured loans off lenders’ balance sheets at knock-down prices and seek to sell them on.

Italy decided not to follow suit, arguing its banking system was more robust, but it has since endured its worst recession since World War Two, which has led to tens of thousands of firms going bust and bad loans surging. And now it faces stricter EU rules on state aid that complicate efforts to set up a bad bank.

“The important thing is to move quickly because the banks that have bad loans do little lending and this is not helping the economy,” said Francesco Giavazzi, a professor of economics who advised a former government on spending cuts.

“Waiting has caused a mess.”

The talks are being held against a backdrop of mutual recriminations between Renzi and European Commission President Jean-Claude Juncker, who has acknowledged that relations with Italy were poor, partly due to the banking storm.

For months neither side has appeared willing to soften their stances, and Brussels rejected Italy’s proposals for a bad bank vehicle which would let banks sell soured loans with state guarantees that would make them more appealing on the market.

Italy's Prime Minister Matteo Renzi gestures during a news conference at Chigi Palace in Rome, Italy January 21, 2016. REUTERS/Remo Casilli

But the presentation of a new Italian plan last week, to give lenders the option to buy guarantees, signaled a desire in Rome to seek a compromise. EU officials have asked Italy to provide further details, with this week’s stock market rout adding extra urgency for a deal to be struck.

MISSED CHANCE?

At the height of the financial crisis, Europe was much more lenient in allowing member states to salvage their sagging lenders. Ireland scooped bad credit off its banks’ balance sheets and into an asset-management vehicle in 2009 while Spain did so in 2011, laying the foundations for far stronger economic growth than the meager 0.8 percent Italy expects for 2015.

Rome argued that its banking system pursued a more conservative loans policy than in many other countries and pointed out that only one bank, Monte dei Paschi, had needed a government bailout in the crisis.

But between 2009 and 2014 the rate of companies failing in Italy has outpaced other developed economies, with 75,000 firms going bust, leaving mountains of unpaid debt with their banks, according to research firm Impresa Lavoro.

Total impaired debts accounted for 17.5 percent of gross loans in Italy at the end of September, compared with only 2 percent in Germany, 4 percent in France and 7 percent in Spain, according to Royal Bank of Scotland.

The European Commission is now taking a more severe line to prevent state aid that it says could distort the market. Under new rules approved by the EU in 2013, shareholders and bondholders must bear the cost of bank failures before taxpayer money can be used in any rescue - including the creation of a state-backed bad bank.

This has become a contentious political issue in Italy - where thousands of small savers hold bank bonds - and made it more difficult for it to follow the examples of euro zone peers who were quicker off the mark in setting up bad banks.

Economy Minister Pier Carlo Padoan said last September that Italy might have missed a chance.

“Maybe this country realized a little late that something should have been done when European legislation still permitted it. The legislation on these things is much more restrictive since 2013, because of state aid rules.”

LOAN PRICING

Another central obstacle to a deal between Rome and Brussels is the issue of how bad loans would be priced.

The Commission says NPLs must be sold at prices determined by the market, which typically do not exceed 20 percent of the loan’s nominal value. But Italy argues the market is not functioning properly and is pricing the loans far too low, according to sources close to the matter.

If Italian banks were forced to sell their bad loans at 20 percent of their value, they would have to book losses of around 20 billion euros after taxes, according to Reuters calculations.

Italy, the euro zone’s third-largest economy with a debt-to-GDP ratio of 133 percent - the highest in Europe after that of Greece - is ill-placed to take on chunks of the bank debt, but it also cannot afford a full-blown banking crisis.

Compounding the problem, Italy has a fragmented, traditionally unprofitable banking system, with 680 lenders, many of them small and regional.

A government reform last year aimed at spurring mergers between cooperative banks to strengthen them has so far failed to produce a single tie-up as the banks involved haggle about top jobs. By contrast, consolidation cut the number of banks in Spain to 14 last year from 55 since the 2008 financial crisis.

But the market turmoil this week has piled the pressure on Italian and EU officials to shore up Italy’s banking system.

EU Competition Commissioner Margrethe Vestager, in an interview with Corriere della Sera newspaper on Thursday, looked to calm worries about the sort of losses stakeholders in lenders might have to chalk up in the creation of bad banks. If there was an element of state aid, the losses imposed on bank shareholders and bondholders could be “very light”, she said.

Meanwhile Antonio Patuelli, president of Italian banking association ABI, urged Rome to conclude talks with the EU on the bad bank plan as soon as possible.

“We think such a long drawn-out negotiation is at the root of the current market uncertainty, along with other factors,” he said. “Any sort of conclusion would be better than this uncertainty.”

($1 = 0.9153 euros)

Additional reporting by Francesca Landini and Silvia Aloisi in Milan, Stefano Bernabei in Rome and Francesco Guarascio in Brussels; Editing by Crispian Balmer and Pravin Char

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