Briana Chui // 21 June 2017

With the potential for an early election by the end of the year, Italy must face the realities of its democratic system: cronyism and corruption; weak banks and Eurozone difficulties; and the suspicious, undeniable, link between the two. Both Italian voters and those looking from the outside in should be aware of the political issues underlying the financial ones in order to know what to look forward to (or dread) come autumn.

Following the December constitutional referendum and former Prime Minister Matteo Renzi’s resignation, President Sergio Mattarella asked Minister of Foreign Affairs Paolo Gentiloni to form a new government. Despite the willingness of Italy’s two largest populist parties, the Five Star Movement and the Northern League, to go to the polls as soon as possible, the Parliament voted in favour of the newly Gentiloni-led coalition government. Since then, Parliament has not found yet a way to harmonise the country’s electoral laws, and The Economist characterises such failure as a return to ‘old fragmented politics.’

With over 360 billion euro accumulated in non-performing loans (NPLs), Italian banks face the potential for an incredible crash, especially in consideration of Italy’s slow economic growth. Monte Dei Paschi di Siena (MPS) —Italy’s fourth biggest bank by assets and the world’s oldest bank—is at a particularly high risk as the amount of NPLs greatly exceeds the bank’s amount of equity by nearly three times. In order to remotely ease this shaky state of affairs that threatens the stability of the single currency, on 1 June the European Commission reached an agreement in principle with Pier Carlo Padoan, the current Italian Minister of Economy and Finance, on the restructuring plan of MPS.

Data from the World Bank indicate that Italy’s annual real GDP growth has been relatively low for years. For example, between 1999 and 2015, Italy – bar Greece – reported the lowest annual real GDP growth in the Eurozone12, averaging just 0.3% per year. This is in stark contrast with France, Germany, and Spain, which reported growth rates of 1.43%, 1.31%, and 1.83%, respectively.

Indeed, such slow economic growth is an important factor in the nation’s banks’ ability to clean up their sheets. To avoid a significant crash in the banking crisis, Italy would need a radical banking system reform—a highly dubious endeavour given the low incentive to utilise other finance tools and eliminate non-performing loans.

Unsurprisingly, the lack of democratic procedure and the lack of control over the banking crisis coincide. If its history of cronyism was not convincing enough, then current times encourage the view that Italy suffers from the parasite of political corruption. Despite the need for immediate change, previous ineffective reform attempts and hesitation to act quickly are no doubt a crippling consequence of politicians who lack the integrity to prioritise the country’s banking crisis over their friends’ corporate interests.

While a significant portion of the NPLs in Italian banks are long-overdue from corporations, politicians have little incentive to streamline the corporate bankruptcy process or to create other means of financing corporations when doing either would make for bad business. More importantly, as a recent International Monetary Fund’s report suggests, despite some improvements in corporate governance, Italy’s banks still remain, de facto, in the hands of political parties. In fact, since the creation of “Foundations” in the early 1990s, politicians have been able to exercise a significant influence over the composition of banks’ internal decision making bodies and their lending activities.

The crisis of Italy’s financial system is extremely complex, as finding a solution has always proven corruption-ridden. If President Mattarella calls for an early election to sooth his nation’s concerns over undemocratic procedures, then Italians must be aware of the imminent danger of non-performing loans, the bankruptcy of banks and corporations at the hands of corrupt regulators.