Truly frightening is the only way to describe it. Buffeted by a surge in withdrawals by retail depositors and a complete inability to raise funds from the wholesale market, Italian banks raised their usage of ECB loans to a staggering EUR 210 bn at the end of last month, up EUR 57 bn from the month before. By the end of 2011, Italy’s banks accounted for nearly a quarter of the liquidity provided by Europe’s central bank. Unfortunately, very little of the liquidity raised has been recycled back into Italian government bonds, and nor is it likely to be – the 10yr yield, for instance, remains above the critical 7% level. Friday’s 5yr BTP auction looms as a critical test of underlying demand for Italian paper, and will be closely watched by the forex market.
At the same time as Italian banks are being forced to access emergency ECB loans, their share prices are collapsing. Unicredit shares closed yesterday at its lowest prices since the late 1980s – in the past four trading sessions alone, it has fallen by 45%, on heavy volume. In the second quarter of 2007, Unicredit shares traded above 40 euros – now, they are worth just 2.4 euros! The trigger for the recent collapse is the dreadful response to the announcement of a heavily discounted rights issue. For the management of Europe’s banks trying to raise fresh capital from the markets in order to satisfy the EBA’s new capital adequacy requirements, this is an absolutely terrifying market reaction, one that will no doubt scupper any plans to go to market in the near future. The conclusion is even more inevitable than before – banks will be forced to accelerate plans to shrink the size of their balance sheets, thereby intensifying Europe’s incredibly damaging credit crunch still further.
Undoubtedly, Italy’s Prime Minister Mario Monti is watching the situation unfold very closely. At the same time, his options are very limited, given the mountain of sovereign debt Italy already has. One possibility is for Monti to approach the EBA and ask for more time to meet the 9% capital requirement. Even if this were granted, banks in other countries would want the same extension. However, market response to any such measure may well be negative.Italy is still on the edge. If retail depositors continue to abandon Italian banks (and frankly, why would they risk leaving their deposits there), the situation will become completely unsustainable. There are no easy answers for Italy. It can only get harder.