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Italy must solve its NPLs problemin a hurry, IMF Director Adrian Tobias says

by Alessandro Merli

The Italian economy needs to “quickly” resolve the problem of banks' non-performing loans (NPLs). And the banking system has to proceed towards consolidation and cost reduction, while on the part of supervisory authorities, the examination of the balance sheets of smaller banks that do not have to undergo direct monitoring from the European Central Bank, should be deepened. These four elements are the key for a “more efficient and secure” banking system, according to Tobias Adrian, Director of the Monetary and Capital Markets Department of the International Monetary Fund (IMF), who spoke to Il Sole 24 Ore – ItalyEurope24 in an interview.

MERLI: In the Global Financial Stability Report, the IMF describes a European banking system in which the legacy of the crisis is still very severe, with a trillion of euros of NPLs. The problem is particularly acute in Italy. How can we get out of it?

TOBIAS: The NPLs are in fact one of the most serious problems deriving from the crisis. In some countries, such as Italy and Portugal, the problem is more serious. In others, like Spain and Ireland, major progress has been made. In others still, such as France and Germany, the problem is smaller. One needs to ask what Italy and Portugal can do.

In Italy, some positive steps have been taken: the creation of the Atlante fund, even if the size was not sufficient to make the difference, and the merger of the mutual banks, seeing as mergers can contribute to resolving the excess of capacity of the sector. What is needed is a more in-depth assessment of the operations of a wider number of banks. Others will have to increase their capital, others further will be forced to get out of the market. There is not a simple solution, but different mechanisms can be used.

MERLI: The European Banking Authority, EBA, has proposed a “bad bank” for the NPLs , or a European asset management company, a solution that has not received full support, while the ECB, via vice president Vitor Constancio, has proposed a European framework with national bad banks.

TOBIAS: The proposal of the EBA in principle can help, but in practice it is difficult to put into effect. We are talking about numerous single loans, that are not securitized. It is not clear how much they are suited to a centralized type of management. The application of accounting standards varies from country to country and at times from bank to bank in the same country. What is considered junk debt depends on how these standards are applied.

The proposal of the ECB could remedy the fact that some countries do not want to share losses, but also at the national level there are operational difficulties for introducing an asset management company. This can play a role but clearly it is not the only path. There are others and the most direct is that the banks continue in their efforts to raise capital and cancel their bad debt. This is a difficult path but inevitable because the losses exist and someone will have to take them on board.

The lesson of the crisis is that the most aggressive countries in facing the problem have had good results, while those where the banking system has a lot of NPLs, high costs, and low profitability, create distortions in the allocation of capital. What worries us more is the business strategies of some banks, that at times depend on their legal nature and their objectives, or those of the sector in which they operate. Some are very solid, others do not turn a profit and assume excessive risks. Low profitability can have an impact on financial stability.

MERLI: Europe has approved the BRRD, a reform that foresees that investors pay the (bail-in) bill, but the first cases, like MPS, or of the two Veneto banks, show that it is not easy to apply. Some say it was still-born, others that it should already be reformed.

TOBIAS: I believe that the reform is well structured. But there are cases, like the ones you have cited, which are a legacy from the past, when the BRRD did not exist. The structure of who holds the subordinated debt of these banks is a problem for the bail-in. From here onward, in the context of this new regime, it will be inappropriate for this debt to be sold like in the past to families and individual savers. But for these cases it is understandable that one does not want to involve families and therefore Italian authorities have asked Europe for an exception.

MERLI: The IMF says that the European banking system has structural problems, as you have already hinted.

TOBIAS: Let me make an example. In Germany, the savings banks make up 50% of the system. They are small banks wth precise mandates to extend credit to the local economy. In general, they function well. Still in Germany, the Landesbanken took on excessive risks, and not from today, they have been doing it for 20-30 years. There is a problem of strategic management that has only been partially faced.

MERLI: According to your analysis, Europe is suffering from over-banking, an excessive offer of banking services.

TOBIAS: This is clear also in Italy. There are too many banks, with very big networks of branches, with a very high cost base. The result is a high cost of banking services, which is not good for the Italian economy. Consolidation, cost reduction, resolution of the NPL problem: these three things together will make the banking system more efficient and more secure.