Italian debt markets are holding their nerve in the face of the latest political crisis to hit Rome.
The country’s ruling coalition may have fallen apart, but its government bonds rallied last week, pushing the 10-year bond yield to a three-year low just above 1.30 per cent. This relative tranquility in the sovereign debt market, in contrast to the dramatic scenes in Italy’s Senate, is largely because of expectations of further easing from the European Central Bank.
Italy’s banks have a big reason to hope this calm continues.
New data published by the Bank of Italy on Friday showed that domestic banks’ holdings of Itay’s sovereign debt passed the €280bn mark in June, hitting levels last seen nearly three years ago.
Despite the efforts of EU policymakers to break the so-called “doom loop” between eurozone countries and their banking systems, Italian banks’ holdings of their government’s bonds are growing larger.
The travails of the Italian banking system are often cited as one of the biggest systemic risks to the eurozone economy. But the country’s lenders have made good headway in cleaning up their balance sheets in recent years, clearing more than €100bn of bad debt from their books over the past four years.
Despite this progress, Italian banks’ large holdings of government debt means that their funding costs are at the mercy of fluctuations in sovereign bond yields.
UniCredit, Italy’s biggest bank, has a seemingly healthy €47bn buffer of common equity tier one capital. Yet its holding of Italian sovereign bonds is even bigger, at €53bn.
It is not surprising then that when bond yields soared last year, UniCredit’s implied cost of funding also surged. UniCredit’s five-year credit default swaps, derivatives that measure the perceived riskiness of debt, began 2018 around the 50 basis point mark. By October they passed the 200bp mark.