Why Italy’s Debts Are Europe’s Big Problem

From the trading floors of London to the gatherings of European leaders in Brussels, there’s one issue that can induce a shudder of financial fear like no other: Italian debt. Europe’s most dangerous stock of public borrowing—some 1.5 trillion euros ($1.7 trillion)—is concentrated on the balance sheets of banks in Rome and Milan. But a rout could quickly sweep in lenders in Frankfurt, Paris and Madrid—the main banks in the rest of Europe are holding more than 425 billion euros of sovereign and private Italian debt, based on a Bloomberg analysis of European Banking Authority data

di Giovanni Salzano, Demetrios Pogkas e Ben Sills

Although Italy’s economy slipped into recession in the fourth quarter, markets are calm for now. But a budget standoff in the fall showed how swiftly sentiment can turn. And if markets should turn south, no one knows exactly where the tipping point will come.

French banks are the most exposed if a sell-off in Italy starts to affect the economy and spread through Europe’s financial system. The country’s two largest banks, BNP Paribas SA and Credit Agricole SA own retail units in Italy.

A populist government prone to infighting and at constant odds with the European Union is what makes the current situation so dicey. It needs to sell more than 400 billion euros a year to keep the show on the road, a situation that forces domestic banks to buy even more debt.
The connection between a weak economy and weak banks, many of which are still vulnerable despite three years of declines in bad loans, has a name: the doom loop.

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