The Big Mess: Italian Finance

Italy is finding itself in a very familiar financial conundrum thanks to the 2008 global financial crisis. On the one hand the country wants to bring in new business, generate commerce, and continue to advance income generation so that the Italians can do better. On the other hand, the famous, “loosey-goosey” nature of how Italy has operated for decades is coming home to roost, barring the country’s banks from moving forward out of the recession without making big changes to controls and compliance systems.

Each of its major banks have to now pass equivalent stress tests to allow the country to be on par with other European banks. This is especially critical for inter-bank networks and cooperation as every country player has to be at a level with business procedures and standards that there is no question about the integrity of their systems. Unfortunately, as Italian banks go through the process, it’s becoming an embarrassing and repeat process of lifting the rug to shake things and finding lots of critters underneath suddenly scurrying from the light.

The central Bank of Italy as well as Italian financial regulators have very deep-seated, strong concerns about whether the country has a whole can actually pass the given stress tests. It’s no joke that organized crime is still very well alive and present in Italy. In fact, the more local and close a business is to a specific region or location, the higher the probability that one or some of its employees have been compromised. This is the situation that regulators are finding as they are going through smaller, local banks and stress-testing them to meet national requirements. As the books are opened, instead of finding solvency the regulators are finding serious discrepancies that then lead to issues such as embezzlement, money-laundering, fraud and similar.

In response, the Bank of Italy has been taking a proactive role to root out problems rather than wait for issues to appear during the expected European Central Bank tests. As the word gets out, bank after bank management team are going through a highly-detailed and scrutinous review unlike any solvency test they’ve experienced before from regulators. And for good reason – Italy’s banks scored the lowest possible score in 2011 stress tests performed by the European Union. Everyone is expecting a repeat performance given Italy’s long-rumored history of financial problems and organized crime.

There are number of factors contributing to a negative outlook on results. Italy’s biggest banks have had to go through a number of bailouts in recent years. There have been cases of hidden derivatives being uncovered as well as diversion of bank assets without normal approvals as well as missing funds. Additionally, the country is desperate to find solid ground financially so that it can climb out of the European recession that is driving inflation and handicapping production. Finally, Italian regulators and industry well-wishers still struggle with the old ways of communities covering their own, “campanilismo,” which often also covers the tracks of financial crimes as well. Even under the best of conditions, the old traditions have created a glut of small banks all over Italy ready and willing to lend to anyone without any leverage or solid assets behind them for solvency, at least to the tune of $156 billion Euros worth of bad loans .

Will the Bank of Italy be able to save the day? While their regulators are giving the effort a valiant try, they face a high climb against old traditions, lots of built in covers and questionable dealings, and a culture of looking the other way to help out local connections. Regulators will likely make a significant dent, especially at cleaning up the number of small banks that just need to be eliminated or shut down to reduce their risk. However, the European Central Bank is likely to still find a significant risk in the country’s banking system when Italy’s visit comes due. And without someone monitoring, the local level is likely to return back to its old ways as soon as the regulators leave town. It’s just the way things have been in Italy for decades and decades.


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