Italian banks caught in sovereign crossfire

July 11, 2011

By George Hay
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

LONDON — Italy can’t just blame speculators for its bank sell-off. Shares in UniCredit and Intesa Sanpaolo, the country’s two biggest lenders, dropped sharply on July 11 despite new disclosure requirements for short-sellers. The reason: banks are getting caught in the sovereign crossfire.

Italy’s banks are hugely exposed to their own government. The two biggest lenders have a combined exposure to the state of over 60 billion euros — not far off their combined tangible book values. With spreads on Italian government bonds on the rise, the risks are increasing.

Hedge funds have noticed this. Investors with long positions on safer euro zone states like Germany and short positions on indebted states like Italy are therefore also shorting Italian banks. The stock market regulator on July 10 decreed that anyone with a net short position exceeding 0.2 percent of the bank’s share capital will have to fess up. But this did not stop the sell-off.

The good news is that Italian banks can cope in the short term. The country’s lenders are quite conservative compared to their counterparts in the euro zone periphery. At the end of the first quarter, the five largest Italian banks by assets had more deposits than loans. This means they are less dependent on flighty wholesale financing, and are insulated from higher funding costs caused by widening Italian government bond spreads. Italian banks have also so far made limited use of the European Central Bank’s weekly liquidity facilities.

Most banks have also strengthened their capital positions since the start of the year. After a 5 billion euro rights issue, Intesa now has a core Tier 1 ratio near 10 percent even after factoring in the latest Basel III reforms. The exception is UniCredit, which probably needs to raise more capital. But it enjoys some respite because most of its wholesale funding comes through its German subsidiary, allowing it to take advantage of narrower credit spreads.

Ultimately, though, the only way for Italy’s banks to remove the target from their backs is for the government to win back the confidence of investors. Until this happens, shorting of Italian banks looks set to continue.

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