Sunday, July 3

ECB policy shift puts Italian banks in the crosshairs

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MILAN — Shares in Italian banks plunged on Friday, hurt by a rise in the country’s debt costs as the European Central Bank prepares to end purchases that put in its coffers a fifth of all Italian government bonds.

The risk premium Italian bonds pay over safer German bonds jumped the most in two years this week, setting a new high since May 2020 after the ECB delivered a stark warning on inflation and flagged a rate hike in July.

With its 2.8 trillion euro ($3 trillion) public debt, Italy has been one of the main beneficiaries of the ECB’s bond buying program, which has kept in check Rome’s borrowing costs.

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Investors are fretting about diverging financing conditions across the euro zone as the ECB unwinds unconventional policy measures, despite a pledge by policymakers to counter unwarranted fragmentation among member states.

As large holders of Rome’s debt, Italian lenders are exposed to a drop in bond prices and their shares show a high correlation with the performance of the country’s debt costs.

Higher bond yields, which move inversely to prices, inflate financing costs because banks must pay a premium over government bonds to raise debt.

Italy’s banking index fell 7% by 1216 GMT, mirroring losses at heavyweights Intesa Sanpaolo and UniCredit.

Smaller peers fared even worse with Banco BPM down 9% and BPER Banca falling 12%. Shares in BPER had risen markedly before a new business plan unveiled on Thursday by Italy’s fourth-largest bank.

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Higher yields can also hurt banks’ capital ratios. However, after suffering heavy capital losses during the sovereign debt crisis of 2011-2012, banks have moved to reduce their vulnerability to market swings.

Nudged by regulators to diversify their sovereign bond holdings, they have also booked a higher proportion of Italian bonds among “held to collect” (HTC) assets that do not require “mark to market” because they are held to maturity.

JPMorgan Stephen analyst Dulake said that Italian banks had more than halved the share of Italian government debt (BTPs) held at fair value among assets available for sale.

“Given that the Italian banking sector has previously acutely felt the sharp edge of BTP volatility, we highlight … how the potential risks of Italian government bond holdings has been materially reduced over the last five-year period,” he said.

He noted Italian banks had beefed up their capital ratios in recent years, and cut domestic bond holdings by a quarter though banks’ BTP holdings still amount to more than core capital.

UniCredit CFO Stefano Porro this week dismissed concerns about higher Italian bond yields saying that over half of the bank’s 41 billion euro Italian bond portfolio was classed as HTC.

($1 = 0.9459 euros) (Reporting by Valentina Za; editing by Agnieszka Flak and Emelia Sithole-Matarise)

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