Why Italy's banking crisis will shake the eurozone to its core

 
They call them le sofferenze – the suffering. The imagery is striking, the thousands of sofferenze across Italy, unwanted and ignored, a problem unsolved. 

 But despite the emotional name, these are not people. They are loans. Bad debts, draining banks of profits and undermining economic growth. 

 The name is less clinical than the English term “non-performing loans”, a reflection of the Italian authorities’ emotional rather than business-like approach to the problem. 

 None the less, the loans are indeed causing real suffering. The €360bn (£300bn) of sofferenze from Italian banks show borrowers are weighed down with debts they cannot afford, while the banks are struggling to offer new credit to the households and firms that need them. 

 When other countries such as the UK, Ireland and Spain ran into trouble, they bit the bullet and cleaned up their banks quickly. Italy did not. 

 In a way, Italy’s authorities had good intentions. When loans turn bad and banks lose money, someone has to pay. It should be the banks’ investors, the shareholders and bondholders who take the risk of investing in return for the chance of profits. Unfortunately in Italy, households are keen investors in bank bonds, and would be badly burnt if they had to face up to those losses. 

 So nothing was done. The bondholders have so far kept sight of their savings, and the banks have been allowed to ignore their bad loans. It saved the country some short-term pain, but the financial problems never went away. 

 Now they have spread to the wider economy, and are morphing into a political crisis with implications across the EU. It could bring down Italy’s government. 

 If no compromise is reached between Rome, which wants to protect bondholders, and the EU, which wants to enforce the rules, it could even bring down the eurozone. 

 This is just the latest phase of the eurozone’s seemingly never-ending crisis, and the International Monetary Fund’s latest assessment of the currency area’s third-largest economy shows why Italy is the latest focal point. 

 The country faces a slow crawl back to economic health, the IMF warned last week. Productivity growth remains weak, debt is still climbing and the economy can’t prosper while its banking sector is sick. 

 As a result, its banks are sitting on a vast stockpile of bad loans, and the situation will only worsen if the status quo continues. 

 In almost any other economy, these astronomical levels of bad loans would be dealt with quickly. 

 This set-up was expected to restore sanity to bond markets since risk was reintroduced to the equation, and to reduce political problems by removing public money from banks. 

 Yet in Italy, the new arrangements also risk intense public anger and financial disaster, as household finances are unusually closely intertwined with the banks. 

 Either way, something has to be done soon. By the end of this month, the European Banking Authority will have published new figures showing the banks’ weak capital positions. 

 The stress tests have been ignored in the past, but it is becoming harder to brush aside international comparisons with increasingly strong banks in other countries. 

 This week, Bank of England Governor Mark Carney said Italy’s banks’ capital positions will only get worse if no action is taken. 

 That is to say, even in their current poor positions, the Italian banks are artificially propped up by unreliable assets which will soon be stripped away from them. 

 The situation is uncomfortably painful, even unbearable for Italy. Expect a political bust-up followed by economic uncertainty and then –if Italians can stomach the other tough economic reforms necessary to free up their labour market and swathes of industry – some form of recovery to put the country back on track to prosperity.