Italian bank stocks tumble as political unrest heightens fears of catastrophic loop

Shares of major Italian banks have fallen since early June amid domestic political upheaval and renewed concerns over lenders’ large holdings of local sovereign bonds.

Banca Monte dei Paschi di Siena SpA led the rout, plunging 46% since June 7 the day before the European Central Bank indicated that it would raise interest rates because the deterioration of the economic context has complicated the plans for a capital increase of 2.5 billion euros. Intesa Sanpaolo SpA, UniCredit SpA, Bank BPM SpA and BPER Banca SpA too fell more than the roughly 15% decline in the EURO STOXX Banks Index through July 22 due to the resignation of Mario Draghi as Prime Minister and political uncertainty ahead of September’s snap election.

The widening spread between Italian and German debt has reignited fears of a so-called catastrophic loop in which Italian banks’ holdings of local sovereign bonds lose value amid a sell-off, raising concerns as to possible government bailouts, which in turn further depresses Italian government bonds. The ECB sought to counter this scenario by deploying a a special monetary policy tool that aims to cap borrowing costs for the weakest eurozone countries.

The catastrophic loop is particularly worrying in Italy because local sovereign bonds represent 11.3% of bank assets, against 7.5% on average in other major eurozone countries, based on June 2021 data from the European Banking Authority. Italian debt concerns have already driven up the cost of insuring the country’s sovereign bonds using credit default swaps at 167 basis points on July 22 against 128 basis points on June 7.

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The ECB announced on July 21 the Transmission Protection Instrument, or TPI, which will allow the Eurosystem to buy securities in jurisdictions experiencing “deteriorating funding conditions”. Policymakers also hiked interest rates 50 basis points higher than expected to rein in rising inflation on the same day.
SNL PictureItalian banks are likely to be among the biggest beneficiaries of the TPI, Moody’s wrote in a July 20 note.

Italy’s FTSE MIB stock index has also fallen far more than other major European benchmarks since June 7.

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