Italy’s Banks Face a New Sheriff in Town

(Bloomberg Opinion) -- There’s an irony in the nomination of Andrea Enria as the head of Europe’s banking supervisory body. The Italian, who currently leads the European Banking Authority, is expected to take over from Daniele Nouy at the start of next year provided the European Parliament and European Union’s council approve.

One of the first items on his menu could well be his own country’s banking system, which is under pressure from rising government bond yields and a slowing economy. Yet any Italian who thinks he’s about to do them a favor is in for a disappointment. The 57-year-old economist has shown himself throughout his career to be independent of Italy’s banking establishment. In fact, he might well be the best person to deal with Rome’s lending woes.

The choice of chairman of the Single Supervisory Mechanism, made by the European Central Bank’s governing council on Wednesday, wasn’t easy. The front-runner was Sharon Donnery, a deputy governor of the Central Bank of Ireland who spearheaded the ECB’s new rules on non-performing loans and was said to have Germany’s backing. The two candidates were competent and qualified. In the end, Enria edged it, probably for his greater experience, which includes coordinating Europe’s stress tests.

It would be easy to query Enria’s selection on the basis of his nationality. Since the 2014 creation of the Single Supervisory Mechanism, the ECB has repeatedly squared off with politicians and regulators in Rome over the health of Italian lenders. The Bank of Italy and the Italian government have routinely criticized the new European architecture for dealing with bank failures, which includes making bondholders take a loss before a government can rescue a lender. They’ve also challenged the ECB’s approach in handling bad loans, which they see as penalizing Italian banks and potentially causing financial instability. So it may look strange to some to put an Italian in charge of Europe’s banking police.

Except it isn’t. Throughout his tenure at the EBA, Enria has shown no bias toward Italian banks. Italy was furious about the stress tests in 2014, where the country’s banks were among the biggest losers. In 2016, the EBA and the ECB chose to look closely at the piles of bad loans weighing on European banks. Once again, many in Rome were unhappy, saying regulators should pay more attention to the opaque “Level 2” and “Level 3” assets that are largely held by French and German banks. Instead, the stress test exposed the weaknesses of Monte dei Paschi di Siena, prompting its nationalization.

Italian banks might well end up as one of the first dossiers on Enria’s desk. Lenders there have made good progress in cutting their non-performing loans and the latest stress tests, published last week, were positive. Yet the environment has changed. Italian yields have risen sharply since the formation of a populist administration in Rome. That has prompted an increase in the funding cost for banks and heavy losses on their holdings of Italian sovereign debt. Italy risks slipping into a new recession because of the uncertainty. Banks may have to deal with new piles of bad loans just as they were running down the old ones.

The ECB faces a difficult choice. So far, it has accepted that Italian banks can take time in dealing with their non-performing loans. While it has some rigid rules on how quickly banks should write them down, these only apply to new issuances. The question is whether the rising recession risk demands that Enria speeds up this approach as supervisor. That might leave new holes in the balance sheets of banks, which may struggle to find new capital. But the alternative is to give up all the gains made in recent years.

Enria is flexible enough to deal with this challenge. Unlike many in Rome, he has backed the ECB’s guidance on new loans. But he’s also been open to less punitive solutions for the existing stocks, including a European bad bank. The exact design of this would need careful scrutiny, largely to avoid clashes with EU competition rules limiting state aid to banks. Still, it would be a useful alternative, particularly for cases like Greece.

Another advantage for Enria is that he appears to be his own person. He only enjoyed lukewarm support from the Italian government in his nomination, with the ruling League refusing to back him in parliament. That should give him some room to be more lenient on Italian banks when he believes that’s needed. At the same time, he’s not Berlin’s man either. Were he to crack down on an Italian lender, it would be hard for anyone to accuse him of ideological bias.

With a patchwork of domestic interests and a banking system that’s still vulnerable to shocks, the job of Europe’s supervisor-in-chief is remarkably difficult. Enria looks a suitable pick.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Ferdinando Giugliano writes columns and editorials on European economics for Bloomberg Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.

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