As the stock prices of Italian banks slide on the prospect of a “No” vote in the Italian referendum – an issue ValueWalk touched on a week ago – a Barclays report notes the non performing loan issue could be a self-fulfilling prophecy, creating a negative feedback loop.
Italy never addressed its non performing loan issue
In the wake of the global financial crisis, many banks, particularly those in Italy, were left with a non-performing loan (NPLs) problem on their balance sheet. High NPLs tend to reduce bank lending by impacting three interrelated issues: profitability, capital, and risk aversion.
In Italy the non performing loan issue did not apparently slow down the initial pace of lending despite concerns raised by bank investors, the report stated.
Now a “vicious” feedback loop is in play, observed the Barclays November 28 report titled “NPLs: The dog that finally barked.” Weak economic growth makes NPLs a more pressing problem, in many cases limiting new loan initiation. This, in turn, makes lending difficult and slows the pace of the economic recovery further, exacerbating the problem even further.
“NPLs act as a constraint forcing banks to clamp down on the supply of new bank loans when financial sentiment turns negative, leading to severe repercussions on investment dynamics, and ultimately on the pace of economic recovery,” the report stated. “NPLs could be the sleeping disease which drags on investment and growth when financial markets finally wake up to reality. As sentiment turns more negative, the bigger issue of NPLs may finally start to bite.”
Non performing loan situation – Other European banks reported as in solid financial footing by Barclays, now is not the time for complacency
The fate of bad bank loans is not equal throughout Europe. While Italy and Portugal have been afflicted by rapidly rising NPLs, investment in Ireland and Spain has “seen a remarkable recovery.” Bank restructuring in these regions helped reduce risk aversion and increased new lending to appropriate private projects.
France, for its part, experienced bank restructuring process prior to the 2008 financial crisis, leaving its balance sheets “in comparatively better shape heading into the global financial crisis.”
In fact, in the region Italy may be a unique negative. “Italy stands out as a clear outlier, with net NPLs standing at 80% of capital compared to less than 40% for the other countries shown.” In this environment loan demand in the country looks healthy, while recently loan growth “has remained subdued,” a point exacerbated after 2014.
With a potential “No” vote in the Italian referendum making a bank bailout more difficult, Barclays advocates for action.
“The Italy case shows that there is little room for complacency,” the report stated, advocating that “authorities should make further steps to implement a multi-faceted comprehensive strategy for NPL resolution.”