Italian banks rally toward the ECB to benefit from new interest rates.
The arbitrage in play:
The third-biggest economy of the EU is facing an existential crisis. With Italy’s public debt touching 140% of GDP, the EU leaders and policymakers worry about the challenges Italy faces.
The issues which Italy faces today are mostly linked to its internal political rift between the alliances and parties. The Eurosceptic populist coalition of M5S and Lega Nord group hasn’t been able to form the government and so the decision to appointing an interim Prime minister by President Mattarella has not gained popularity among the coalition. Instead, the interim Prime Minister is now set to hold a fresh election. If the new election results in the success of pro-EU groups, it may help in soothing the economy. However, If the anti-EU coalition comes with the majority it will need to form a government which could deepen the crisis, and negatively impact the fate of EU.
While measures like cross-border mergers of banks could help strengthening the currency and help financial stability, it may prove too late to help countries like Italy which face political turmoil. The political uncertainty along with negative ECB deposit rate left financial institutions are more exposed to risk-taking
As Luis de Guindos, Vice President of the central bank of EU told CNBC, “The low-interest rate environment affects the investment strategy of the asset managers and in this respect, this could give rise to bigger risks”. The banks want to avoid negative interest and are forced to invest heavily instead of deposits. This result in the risky investment which left the system exposed to instability.
The two-tier system is seen as the much-needed ease by the ECB for the financial manager in Italy as they rally to benefit from the scheme to maximum. Italian banks are receiving less money from the EU countries due to a debt-driven economy. On the other hand, Italy is forced to pay more to the EU countries than it received. But according to the Banca d’Italia, the reserves of Italian banks in the ECB surged in October which means Italian banks are taking advantage of this arbitrage opportunity offered by ECB under a two-tier system.
In this scenario, the two-tier system can prove to be the much needed oxygen for the Italian banks. They have the opportunity to borrow from banks elsewhere in Eurozone at negative rates and deposit in central banks for free, making a profit on the difference.
While Italy has enough room to raise the deposits by €35bn and still be covered by the exemption, it may not be the case for all Eurozone countries facing financial difficulties. As the banks in larger, richer countries such as Germany or France won’t be able to take benefit from the scheme its maximum, the Eurosceptic groups in these countries may use this against the EU in these countries resulting in more anti-EU sentiments.
Although some may see this move as assistance to the struggling financial organizations, finance experts like Marco Troiano, director at Scope Rating said that ECB is not driven by bank profitability concerns. Some skeptics also say that the benefits of this exemption under two tiers for the whole Eurozone banking system would not be more than €3bn.
However, the underperforming Italian and southern European banks are likely to be the most happy with the decision and availing the relief to the full extent while proving the ECB move effective. It can be expected that if ECB is happy with the outcomes of the tier system, it could cut the already lowest interest rates further while increasing the exemption multiplier to ease the pressure.