Italy’s Banks Have To Be Fixed—quickly

The health of the fourth-largest economy in the European Union is in jeopardy

In recent years, Europe has grown accustomed to financial panic. The latest cause for alarm is the troubled banks of Italy. The sudden selloff of Italian bank shares shows that decisive action on their nonperforming loans can’t wait any longer. Italy and the European Union are discussing a plan. They need to wrap up the talking and act.

There’s no longer any pretending that the issue is confined to smaller lenders, such as the four that the government rescued last November. Italy’s ratio of nonperforming loans, at 17 percent, is more than four times the European average (and Europe’s banks are in worse shape than those in the U.S.).

The answer is to create a “bad bank” to absorb these loans, so the rest of the system can be restored to health and serve its essential purpose of lending in support of economic growth. The question is how to allocate the accumulated losses across the system’s various stakeholders.

The EU has new rules that rightly require bank shareholders and creditors to carry much of this burden. It’s also insisting that Italy curb its public borrowing, limiting the scope for public subsidy. Italy’s prime minister, Matteo Renzi, has pushed back against some of the European Commission’s demands.

A little more flexibility on both sides can bridge this gap. The EU should remember that Renzi is trying, against strong domestic opposition, to be the pro-market, fiscally responsible reformer that Italy needs. In the larger task of reforming Italy’s economy and governance, he’s the ally Europe wants.

Further delay would be dangerous. Italy has a vibrant business community and excellent long-term prospects, but an unrepaired financial system puts them in jeopardy. The last thing the rest of Europe needs is a worsening crisis in one of its largest economies, just as the EU and its central bank are struggling to revive demand and avoid the trap of deflation. <BW>