What's going on?
A deal was made late Monday night to address concerns about Italian banks. And this is a big deal: banks are fundamental to economic growth and Italy is pretty darn important to eurozone (as its 3rd biggest economy).
What does this mean?
Italy’s problem is that its banks have lent a lot of money to borrowers that are unlikely to pay them back in full – there are estimated to be more than €300 billion of such “bad loans.” And, generally speaking, these bad loans are limiting Italian banks from making new loans to companies that could do economically positive things for Italy, like build factories and hire workers. So, at the urging of Italy’s government, some of the bigger, stronger banks have joined forces to create a fund that is dedicated to buying bad loans from Italy’s weaker banks (and in some cases, they will directly invest cash into the weaker banks). The idea is that, eventually, it will help flush out the bad loans and make room for new, good loans.
Why should I care?
For markets: Will it be enough? So far, the fund is only €5 billion in size (tiny compared to the amount of bad loans). As one UK-based investor said, “They could need about ten times this amount.” Shares of Italian banks, which hit multi-year lows last week, rallied significantly as news of a potential deal leaked in the days ahead of the announcement – but fell sharply on Tuesday, suggesting that the deal fell short of investors’ hopes.
The bigger picture: If this doesn’t work, the sky could fall. The fund that’s investing in the bad loans has been named Atlante – after the Greek god tasked by Zeus with holding up the sky. It’s a telling name because, if the Italian banking system collapses under the weight of bad loans (which isn’t a totally preposterous fear), it could be disastrous not just for Italy but for the eurozone as a whole (it could conceivably lead to a re-run of the 2012 European debt crisis).