One of the worst markets hit in the last two-weeks has been Italian banks 

Bad debt

And the problem for Italian banks: bad debt and piles of it.

The Italian government is currently looking to prop up the ailing banking sector ahead of the new eurozone stress test results. According to Rabobank, several Italian newspapers have been reporting that the government is again looking at a private sector solution, but these reports have been contrasting and it is doubtful whether this will be sufficient to provide a structural solution.

“But so far as the government is involved, Italy may be in a bind here, and not only because their European partners are protesting against the recapitalisation,” write analysts at the Dutch bank.

“If Italy does manage to get a green light for the recapitalisation, the funds required to reinforce the Italian banking system may well be coming from Italy’s public finances. And this is where the real pain could come from.”

Rabobank says that these additional funds, while relatively small in terms of GDP, could be the straw that breaks the camel’s back as it would add even more debt onto Italy’s mountainous debt pile, and may trigger a ratings downgrade.

“Italian ratings are already at BBB- for S&P, though we must also add that DBRS still ranks the country at AL. Still, if these ratings start to come under pressure from the agencies, this could lead to speculation that Italy may eventually fall out of the investment grade bucket. This would have a major impact – in the first place in terms of the eligibility of Italian bonds for the PSPP.”

And the political landscape?

And if the financial situation was not bad enough, Italian PM Matteo Renzi has planned a referendum on the Italian constitution in October and has said that if he loses that he will resign, causing a period of uncertainty (Brexit) which will continue to harm the economy.

Rabobank concludes: “Moreover, new elections might very well be won by the anti-establishment Five Star Movement, which is campaigning to pull Italy out of the eurozone. With the Five Star Movement only trailing Renzi’s Democratic Party by a small margin in recent polls, the prospects of new elections and the very uncertain outcome could send Italy into a tailspin.”