THE BLOG
07/15/2016 10:38 am ET Updated Jul 16, 2017

Italy is more dangerous than Brexit: Europe's next crisis could be systemic

The noise about Brexit, as historically and politically significant as it could be, has, over the past three weeks, allowed Italy to hide. However, whether its is the Financial Times about Italy's banking crisis, the New York Times, Italy's Plan for Banks could Roil Europe or The Economist Italy's teetering banks will be Europe's next crisis, serious media all came within a week to remind us that the reeal risk for Europe is Italian banking.
Why is Italy Protected? A lousy EU governance favrign large countries?
Every observer of the European Union tries to understand how Italy manages to escape the rules, hide its deficit and refuses to tackle its 2.3 billion euros indebtedness representing 132% of its GDP while the European rules allow a maximum of 60%.
How could Italian banks bad debt reach 17% of gross loans from 6% since the financial crisis?
There is an explanation that I hate to mention: the heads of the European Central Bank, of the European Banking Authority and of Director-General Economic and
Financial Affairs of the European Commission are all Italian.
But there is something more fundamental: the weakness of the governance of the European Union. The perfect example is the process to fine Spain and Portugal for breaching some ratios a few years ago and the lack of sanction when it comes to Italy, and probably for that matter Germany and France.
Unless smaller countries unite to create a counter-power to the large countries to derail their complacency, they risk to be the first victims of the ECB or the Commission policies that favor large countries.
Italian banks close to the brink could create a European banking crisis
Monte dei Paschi di Siena, the third largest bank, will need to be rescued. After capital injection, it still lost 90% of it market capitalization. It was foremost a political institution of the Partito Democratico and the Banca d'Italia and the Tesoro did not exercise their regulatory powers to stop it. The shortfall of equity reached 8 billion euros, while the ECB stress test limited it to 2 billion.
Banca Popolare di Vicenza (who passed the test) needs to be recapitalized, but its shareholder, Unicredit, Italy's klargest bank, does not have the 1 billion euros needed without undermining its own capital rules
These situations will not just be limited to Italy. BNP Paribas owns Banca Nazionale del Lavoro, the fourth largest bank and Deutsche Bank owns a bank with 25 billion euros of assets. An Italian banking collapse would immediately threaten France and create a European , and probably world systemic bank crisis.
Needless to say, the European Banking Union rules have not been applied. The two banks should have been put under the European Banking resolution and their Board and management replaced. Who will dare?
Italy's Government is conflicted
The extraordinary ownership of Italian debt by Italian banks reached 17% of their assets of which 10.4 % in Italian Bonds. Prime Minister Renzi vetoed a measure that would have limited the Eurozone banks ownership to 10% of assets. Nobody will challenge him since he needs the complacency of his banking system to finance its huge deficit.
The Bermuda triangle is now in place between the European Central Bank overexposed on Italian debt, Italian banks and Italian sovereign debt. It does not matter how the crisis will explode. The whole system will collapse.