As Italy geared up for the referendum this weekend, concerns for the struggling banking sector mounted in the face of a possible defeat of financial reform proposals. Italy’s banks are facing an ever-growing burden of non-performing loans (NPLs) and its government’s debt is one of the largest in the eurozone. Italian banks currently hold about €360 billion in NPLs, equivalent to a fifth of the country’s economy. Given the significant size of the Italian economy in the eurozone, and its volatile political climate, commentators are pointing to its banks as a potential flashpoint that may trigger wider shockwaves.
Italy’s gross domestic product (GDP) also remains about 8 per cent smaller than it was at the beginning of the 2008-9 financial crisis. The country’s poor economic performance has prevented the government from servicing its debt with tax revenue, and has increased the chances of business failure leading to default on loan payments.
In the face of political uncertainty, solving the problems in the banking sector is a challenge of gargantuan proportions. Prime Minister Matteo Renzi has honoured his vow to resign if his reforms were defeated. This may trigger an early general election in Italy and the possible victory of the Five Star Movement, an anti-euro political party. While European Commission surveys have consistently reported that Italians generally favour remaining in the eurozone, financial markets are undeniably sensitive to political upheaval.