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By Tony Termini
Monte dei Paschi di Siena is not just the oldest bank in Italy. It is the oldest bank in the world. Founded in 1472, Monte dei Paschi di Siena is also Italy’s third largest (Source: Company website).
Unfortunately, it is also one of the country’s most troubled, which makes it a huge problem for the economy of the entire European Union. Adding to this problem is the fact that Monte dei Paschi di Siena isn’t alone. Most of Italy’s banks are struggling. Plagued with massive losses of customer deposits and reeling under a heavy burden of nonperforming loans, many Italian banks must raise additional capital to stay afloat. European Commission economists estimate that Italian banks hold nearly €200 billion in bad loans (Source: EuroStat.com).
Luckily for Monte dei Paschi di Siena, the Italian government approved a bailout for banks late last December. Here’s the problem. That was the third time Monte dei Paschi di Siena has needed to be bailed out. And, there is nothing to suggest that its woes won’t continue going forward, inching it again close to the brink of disaster. It’s not as if Monte dei Paschi di Siena or any other bank in Italy (and there are still quite a few in similar trouble) can rely on the economy to come to the rescue.
Europe’s Third Largest Economy Continues To Struggle
The Italian economy, the third largest in Europe with GDP in excess of €2 trillion, has been in decline for nearly a decade. It has contracted by some 10% since 2007. The country’s unemployment rate stands at nearly 12%. Public confidence remains low and sentiment among both consumers and businesses (Source: Bank of Italy).
(Chart Courtesy of EuroStat.com)
None of these factors is helpful for Italy’s banks. Complicating matters is the fact that earnings are hard to come by right now. Generally speaking a bank earns money on the spread between the rate it collects when it loans out money and the rate it pays out on deposits. The higher interest rates are the greater that spread is, and the better the earnings environment. Interest rates in Italy are near zero, which provides little opportunity for Italian banks to earn anything on the spread. Adding to this dilemma is the continued loss of depositors and an ongoing problem with under-performing and non-performing loans, the symbiosis of which exacerbates an already precarious situation (Source: Bank of Italy).
While I am not suggesting that Monte dei Paschi di Siena is in imminent danger of folding, I am genuinely concerned that the possibility does exist. At a certain point, if the Italian economy does not improve, or the European economy falters from its current anemic pace of growth, then the risk of default is heighten. And, at a certain point, both the Italian government and the European Commission will reach the point at which offering further bailouts just won’t be an option.
Is Another Shoe About To Drop In The Italian Banking Sector?
Even if Monte dei Paschi di Siena finds a way to get out of its current predicament and somehow shore up its balance sheet enough to survive long into the future, as I mentioned earlier, there are still several other banks in Italy whose problem loans outweigh their equity. These include Banca Popolare di Vicenza, Veneto Banca, and Banca Carige Italia. Among Italy’s smaller-market banks with liquidity problems, at least four (CariChieti, Banca delle Marche, and CariFerrara) have already been bailed out by the Italian government (Source: Reuters Italia).
The risk to investors is that a failure of any of these banks could lead to a localized panic in Italy, where depositors withdraw en masse. A run on Italian banks would likely have a spillover effect across Europe. Even if banks in other countries in the union weren’t subjected to runs, their stability and viability would almost certainly be questioned – if not by depositors or regulators – at least by investors. The failure of a big Italian bank could set off a chain reaction that ultimately might send the entire region into recession.
These are the kinds of events that lead prudent investors to own hard assets like gold. Heaven only knows what the real risk is that exists in the Italian banking system. What’s happening at Monte dei Paschi di Siena, Banca Popolare di Vicenza, Veneto Banca, Banca Carige Italia, CariChieti, Banca delle Marche, and CariFerrara may be short-term problems that will be fixed soon. The balance sheets of each of these banks would very likely improve with an uptick in Italian GDP. But, the risk is still palpable enough to warrant a hedge. And, in my opinion, allocating a portion of ones portfolio to gold is a reasonable position to take.
Now Would Be A Good Time To Consider Gold
Investments in gold tend to outperform financial assets in times of trouble or unease. A durable allocation to the metal in an otherwise meticulously diversified portfolio has been proven to reduce the portfolio’s standard deviation and enhance its returns over both intermediate-term and long-term investment horizons.
Whatever the risk a failure of an Italian bank might impose on the European banking system now is probably a good time to consider adding gold to portfolios.
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