By Chiara Remondini

An increase in Italy’s bond-yield spread is a risk for its domestic banks and is adding to tensions in the financial system, according to cabinet undersecretary Giancarlo Giorgetti.

“The spread is a risk for banks, which we can’t ignore,” Mr Giorgetti, a senior official in deputy prime minister Matteo Salvini’s League, said in an interview with Il Messaggero.

The situation requires “a serious and responsible approach from the government”, he said. Italy’s budget standoff with the EU enters its next phase later today as Prime Minister Giuseppe Conte’s government faces a deadline to explain why it deviates from eurozone rules.

The bond spread, public debt held by banks, and new EU banking rules are straining Italy’s financial system, which “may generate the need to recapitalise some institutions that already have capital fragility”, Mr Giorgetti said.

Its 2019 budget deficit target of 2.4% of GDP is a “ceiling” and may not need to be used completely, he said.

Italy’s banks are reeling from the impact on their capital levels of soaring government bond yields, which touched a five-year high on Friday.

They’re also sitting on a €260bn pile of non-performing loans, the biggest in the EU, from the last financial crisis.

It’s important to start a frank and constructive dialog with the European Union,” Mr Giorgetti said. “We’re responsible people and we’ll do things in a responsible way,” he said.

The 10-year yield spread over Germany, a key risk barometer, dropped from 341 basis points, the highest level in more than five years, after European Commissioner Pierre Moscovici said on Friday that EU wouldn’t interfere in the government’s economic policies.

A spread greater than 400 basis points would not be sustainable for Italian banks, according to an October 7 note by Credit Suisse. A 200 basis-point broadening from the end of June would reduce the capital ratio of Italian lenders’ by 66 basis points, it said, which could trigger the need for capital increases. Moody’s Investors Service cut Italy’s credit rank by one notch to Baa3, its lowest investment-grade rating

- Bloomberg