Mike (Mish) Shedlock | Jun 30, 2016 05:30AM ET

Italy’s third largest bank by assets, Banca Monte dei Paschi di Siena SpA (OTC: )i is on the death bead. It’s been there since mid-2014.

Italian banks in general have €200 billion in non-performing loans. They have another pile of troubled loans that are late just some of the time.

To address the problem, Prime minister Matteo Renzi hatched a half-baked scheme dubbed “Atlas”. The idea was to leverage a mere €5 billion to address a €200 billion hole.

As predicted, “Atlas” quickly died. Now, Renzi wants to use Brexit as an excuse to use state funds to bail out Banca Monte dei Paschi, but German chancellor Angela Merkel shot down that idea on Wednesday.

Please consider Matteo Renzi Rebuffed on Move to Sidestep Bank Bail-Ins.

An attempt by Matteo Renzi to use Brexit-driven market turmoil to secure EU approval for Italy’s plans to recapitalise its banks without triggering bail-in rules has been rebuffed by Germany and the European Central Bank. “We wrote the rules for the credit system, we cannot change them every two years,” Angela Merkel, Germany’s chancellor, said on Wednesday in her first public comments since the Italian prime minister floated his idea on Monday. It is the fourth attempt by the government since November to try to gain approval from the EU regulators to use state funds to bail out its banks. All previous attempts were watered down so they did not break EU rules. The move reflects concerns in Rome about the potential of a bank crisis to unseat the government. Mr Renzi faces a constitutional reform referendum in October on which he has staked his political career. Senior bankers are also concerned by how their banks will fare in stress test results, due to be published this summer, which might prove a trigger for another sell-off. One senior diplomat in Rome described Mr Renzi’s move as an “attempt to hijack the EU meeting to fit his own political objectives that everyone saw coming”.

What is the Italian Problem?

Let’s turn our attention to an article from Tuesday to fill in some missing pieces: Why Renzi’s Latest Bank Rescue Matters Far Beyond Italy.

The strict EU rules against state-backed rescues took years to negotiate and are so new they have barely been tested in a crisis with a major bank. But they were an essential precondition to eurozone integration; without these guarantees Germany would not have accepted the risk-sharing involved in creating a banking union. Nicolas Véron of the Bruegel economic think-tank said the credibility of the EU’s post-crisis rule book is on the line. “This test is bigger than any than banking union has already passed,” he said. Concerns are focused on the banking sector’s €200bn of gross non performing loans, known as “sofferenze“, of which about €85bn have not yet been written down. The bad loans, built up during Italy’s three-year recession and a decade of stagnation, are weighing on the banks’ already weak profitability and limiting their ability to lend. Italian politics also plays a part. Banca Monte dei Paschi di Siena, Italy’s third-largest bank by assets, is facing the biggest difficulties. It happens to have close ties to Mr Renzi’s centre-left Democratic Party. Any restructuring would hit influential creditors and thousands of retail investors. For Italy, the question is whether a capital injection will ultimately address the deep malaise of 600 banks that operate on a business model that may no longer be viable. “Ultimately to solve the problem losses will have to be allocated, there will have to be closures and mergers and fewer branches. Whatever happens this needs to be done,” said one European regulator familiar with the discussions. “Just fiddling with the rules won’t make this go away.”

Italian Banks Achilles Heel of the Eurozone Financial System

Three days ago, Ambrose Evans-Pritchard at the Telegraph wrote Italy Eyes €40bn Bank Rescue as First Brexit Domino Falls.

As noted above, that rescue attempt got trashed yesterday by Merkel. But the article has some other details worth noting.

Italy’s banks are the Achilles Heel of the eurozone financial system. Non-performing loans have ratcheted up to 18pc of total balance sheets as a result the country’s slide into depression after the Lehman crisis. The new bail-in reform this year has brought matters to a head, catching EU authorities off guard. It was intended to protect taxpayers by ensuring that creditors suffer major losses first if a bank gets into trouble, but was badly designed and has led to a flight from bank shares. The Bank of Italy has called for a complete overhaul of the bail-in rules. It is now almost impossible for Italian banks to raise capital. They are caught in a pincer as the ECB simultaneously demands compliance with tougher capital adequacy buffers, in some case demanding fresh infusions of capital three or four times. Mr Codogno said the ECB is unwittingly destabilizing the banks in an overzealous attempt to make Europe’s banks safer. Hedge fund veteran George Soros warned that Italy faces the risk of a “full-blown banking crisis” that could bring the rebel Five Star Movement to power as early as next year. The banking squeeze has become politically explosive in Italy after thousands of small depositors were wiped out at four regional banks late last year. They were classified as junior bondholders, even though most of them were just ordinary savers who did not realize what was being done with their money. Mr Renzi may be forced to take matters into his own hands and enact a unilateral sovereign rescue of the Italian banking system in defiance of the EU, unless he wins concessions soon from Brussels. Those who know him say he will not go down in flames for the sake of European ideological purity.

Banca Monte dei Paschi

Get Out of Italian Banks Now!

I reiterate the call I made on December 29, 2015: Get Your Money Out of Italian Banks Now!

A bail-in is highly likely, depositors may be wiped out. No bank in Italy is safe.