BANKS in Italy fared better during the financial crisis than many of their peers, sparing Italian taxpayers the bail-outs their counterparts in other countries had to shoulder. But although they stuck to their cautious business models and avoided fuelling a big housing boom and bust, Italy’s protracted recession has enfeebled them. It has caused bad loans to soar, which in turn has prevented them from supporting a still weak recovery with new lending.
The burden of non-performing loans (NPLs) in Italy is now immense: they amount to €350 billion ($370 billion), the equivalent of 21% of GDP. With these unproductive assets tying up their capital, Italian banks are unable to extend new credit to businesses. In fact, they are lending out less in an effort to shore up their balance-sheets (see chart).

The government would like to fix all this by setting up a “bad bank”—an asset-management company that would strip bad loans off the banks’ books and thus enable them to resume normal service to businesses. Schemes of this sort recently helped Ireland and Spain overcome big banking crises. BCG, a consultancy that has worked with the Bank of Italy on the issue, reckons that paring the most intractable NPLs to the level of 2009 would boost GDP by 1.5-2 percentage points over three years. Given the weakness of Italy’s recovery, that would be a huge leg-up.

However, such a gain would not come cheap. That was highlighted this week by the central bank’s decision to wind up four lenders whose total assets were only €47 billion. Even though these were small outfits, the cost of the rescue came to €3.6 billion. That will be used to cover losses and to recapitalise the new “bridge banks” into which the deposits and good loans will be transferred. Around a third of the sum will come from “bailing in” shareholders and junior creditors; a newly created “resolution fund”, financed by contributions from other Italian banks, will provide the rest. Intesa and UniCredit, Italy’s two biggest banks, will lend to the fund immediately to kick-start the operation. The Italian government is not putting up any of the money directly, although the Cassa Depositi e Prestiti (CDP), a publicly controlled development bank that often comes to the aid of the government, is involved. The proceeds of the eventual sale of the bridge banks, plus any money recovered from the bad debts, will go to the fund.

Sorting out these four banks alone will mop up four years’ worth of contributions to the resolution fund, according to RBS, a British bank. Putting all the bad loans in the Italian banking system into a bad bank would be a far more ambitious project. Any such asset-management company could not be financed exclusively by the banks themselves; it would require some form of state backing. That is particularly problematic for the Italian government, whose debts as a share of GDP are second only to Greece’s in Europe. Moreover, any initiative has to be approved by the European Commission, which worries that banks would be relieved of their NPLs on overgenerous terms, giving them an unfair advantage. Although it approved several such measures during the heat of the crisis, it is now taking a sterner line. A hybrid solution may be the answer. This could involve a private vehicle whose borrowing would be guaranteed by CDP.

Other steps would still be needed to pep up Italy’s lenders. The government is already seeking to rationalise the banking industry by requiring big mutual banks (popolari) to turn themselves into joint-stock companies. It has also introduced a reform of bankruptcy proceedings to speed up credit recovery, which can take up to seven years. Italy cannot wait that long to sort out its bad loans.