Why’s France so Worried about Italy’s Showdown with Brussels?

The French megabanks are on the hook.

By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.

France was just served with a stark reminder of an inconvenient truth: €277 billion of Italian public and private debt — the equivalent of 14% of French GDP — is owed to French banks. Given that Italy’s government is currently locked in an existential blinking match with both the European Commission and the ECB over its budget plan for 2019, this could be a big problem for France.

On Friday, France’s finance minister, Bruno Le Maire, urged the commission to “reach out to Italy” after rejecting the country’s draft 2019 budget for breaking EU rules on public spending. Le Maire also conceded that while contagion in the Eurozone was definitely contained, the Eurozone “is not sufficiently armed to face a new economic or financial crisis.” As Maire well knows, a full-blown financial crisis in Italy would eventually spread to France’s economy, with French banks serving as the main transmission mechanism.

France isn’t the only Eurozone nation with unhealthy levels of exposure to Italian debt, although it is far and away the most exposed. According to the Bank of International Settlements, German lenders have €79 billion worth of exposure to Italian debt and Spanish lenders, €69 billion. In other words, taken together, the financial sectors of the largest, second largest and fourth largest economies in the Eurozone — Germany, France and Spain — hold over €415 billion of Italian debt on their balance sheets.

While the exposure of German lenders to Italian debt has waned over the last few years, that of French lenders has actually grown, belying the ECB’s long-held claim that its QE program would help reduce the level of interdependence between European sovereigns and banks.

If anything, the opposite has happened: thanks to the ECB’s tireless efforts to underpin the Eurozone’s bond markets (by doing “whatever it takes” to make sovereign bonds virtually risk-free), banks have been able to make a tidy margin by simply bulk-buying government bonds at officially zero risk.

A few years ago fiscally hawkish Eurozone countries such as Germany, the Netherlands, and Finland lobbied to put an end to this practice by removing the risk-free status of certain risk-prone sovereign bonds. But their efforts were staunchly opposed by French, Italian and Spanish politicians and bankers, who feared that any such move would result in market mayhem.

Today, market mayhem is not off the cards. The dispute over Italy’s draft budget is unsettling investors. This is reflected not only in the spread between Italian and German ten-year bond yields, which hit four-year highs a couple of weeks ago, but also the sentix Euro Break-up Index, which in October rose to its highest level since April 2017, mainly due to the strong rise in the Italian sub-index.

On a more positive note, investors do not yet appear to fear negative contagion effects, as reflected in the low rise of the Greek sub-index and the index for the contagion risk, which even dropped slightly from 36% to 33%. In other words, investors don’t yet fear for the stability of the Eurozone. But as Bloomberg points out, the exposures of French and German banks to Italian debt mean that those countries’ leaders are strongly incentivized to seek a compromise in the current standoff over Italy’s government budget.

Italy’s coalition partners are perfectly aware of this fact. They know that during the Greek crisis of 2010-11, French and German banks held around $115 billion of Greek debt. That was enough to convince the French and German governments of the day to offer Greece a partial bondholder bailout, though eventually, some private-sector bondholders were given a large haircut as part of the deal.

This is all perfectly understood by Italy’s government, as is the fact that French, German and Spanish banks are now far too exposed to Italian debt for their respective governments to even entertain the idea of pushing Italy to the edge. That knowledge is fueling the coalition government’s bravado, with some lawmakers now even talking about extending Italian government funds to struggling Italian banks if economic conditions continue to worsen.

“Brussels would love to see our defeat,” said Claudio Borghi, the Lega economics chief and budget chairman in the Italian parliament. “They think that we’ll surrender if they cause a crisis for our banks. But we still have €15 billion left in the bank rescue fund from the Renzi era. It is not a great situation but we’re still relatively comfortable. In the end, it will be they who have to back down.”

Lorenzo Bini-Smaghi, a former member of the ECB board, disagrees. He believes that events are following a similar script to the onset of the Eurozone debt crisis in 2011, when surging bond yields caused a massive contraction in credit.

“Italy is going straight into a wall,” he says. “The economy risks tipping into recession in the fourth quarter. The banks have already cut loans over the summer, as soon as the spreads began to rise. The Italian government has not understood this. You can’t see the wall yet, but the crash is going to be violent.”

It may sound like rank fear mongering from a dyed-in-the-wool eurocrat, but besides being a former central banker, Bini-Smaghi is also the current Chairman of Société Générale, France’s second largest bank, which is presumably filled to the gills with Italian debt. As such, he probably has even more to fear from a full-scale Italian debt crisis than most. By Don Quijones.

But outside Italy, credit markets are sanguine, and no one says, “whatever it takes.” Read…  Italy’s Debt Crisis Thickens

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  27 comments for “Why’s France so Worried about Italy’s Showdown with Brussels?

  1. Gorbachev says:

    America is borrowing 1.5 trillion a year to fund

    their loan distributions(tax cuts). Three billion doesn’t

    sound like much, but it is -just try and earn that much.

    I am losing perspective of how much is too much.

    The only way to know we have hit excess is if credit

    seizes up.

  2. Copernicus says:

    French banks walked from their Greek exposure. They just happened to sell their Greek debt exposure to the government when th Pe haircut to privately held, but not govemrnt held, Greek debt was taken. Marvellous timing. The French lead the negoatiations.
    It’s one of the biggest jobs ever.
    The French banks are very likely to have remembered this.

  3. nick kelly says:

    Germany, with a larger healthier economy than France is much less threatened by its 79 B exposure than France is to 277 B.

    This suggests the possibility of a rift between the core founders of the EU project re: their motivation to let Italy increase its deficit.

    After the Greek episode demonstrated that sovereign debt is no more immune than any other from default ( as if that needed another demonstration) the French banks seem to have been reckless and / or stupid to bulk up on debt from a country with a checkered history of financial probity.

    To return to the first point: if France is now a financial captive of Italy, Germany will not want to be. It won’t want its banks to accumulate any more Italian bonds. After the recent downgrade to one level above junk they probably don’t need to be told this, but most likely have been.

    Germany will also not want to help an ECB bailout of Italy, which looms not far in the future if Italy is allowed to almost triple its deficit.

    • blindfaith says:

      The EU is cooked, held together by NATO and a common but profitable hate.
      Germany has it’s own problems simmering and soon to boil over.

      • nick kelly says:

        Maybe true about the EU but no economist would trade Germany’s problems for those of the US.
        If the EU does break up and Germany goes back to the D-mark, it would be a much harder currency than the $US.

    • Atu says:


      Italy has target 2 deficit of over 400 bn, owed primarily to Germany. All your talk of French slack “private” funding is outstripped by Germany. Maybe Germany will be “kind” and re-attribute loss according to capital key to remaining countries, if there are any.

      The only reason people propagate this hype of one country vs. another within Eurosystem is because they themselves adhere to the Euro project. The bias stands out a mile and fools no-one – many are beyond outrage by this purposeful manipulation of European political, social and economic reality, and will applaud the day it is disassembled, the more so if Germany pays for its part in the corruption and suffering it has funded and supported in pursuit of increasing or safeguarding own position.

  4. MooMoo says:

    No matter how you slice it and dice it by country… the Euro is headed for the toilet.


  5. blindfaith says:

    Yield chasing….it is all about yield chasing. The Achilles Heal for the EU is different interest rates for different countries. Not really much different than borrowing FX in another countries fiat and suddenly not being able to get enough of that countries cash to pay on the loan. Happening now, juts look around.

    So France 10 year bond is 0.7 and Italy is 3.4%…where would you put your money Mr. Banker? And with the EU assurances? Never mind about those trillions off the books debt instruments that is the elephant.

    BOOM !

    • MC01 says:

      Real world yields are considerably lower than that.
      Today the Italian government sold two tranches of bonds, one with 5 years maturity and the other with 10 years maturity: the former yields 2.45% and the latter 2.8%. The six months tranche sold yesterday yields all of a pitiful 0.15%. The next auctions are on 12-13 November and it will be interesting to see if yields keep on inching forward or not.

      Allow me to say here that most people have no idea how debt-addicted the French and Italian economies are, especially to low-grade, low-yielding debt. Italy’s Housing Bubble 1.2 is wholly built on these shaky foundations, as is the French government’s return into the capital of perpetually ailing firms such as Renault and Orano (built from the ashes of bankrupt Areva).
      Mr Draghi’s last action will be beating the tattoo (from the old military Dutch term “doe den tap toe” “turn off the tap”, a perfectly apt metaphor), then all bets are off as he’ll ride into the sunset. Good riddance.
      The Italian government, no doubt with France anxiously looking over their collective shoulder, is throwing one colossal tantrum to get the tap opened at full flow again even before it’s closed. I am much fearful they will succeed…

  6. Steve clayton says:

    Very interesting situation. As of today the Italian economy has 0% growth. Italian Banks are calling in overdrafts even from reliable customers. The Italian Banks have requested continued ECB support for their direct funding as they can’t afford increased funding costs. 400 billion Euro debt vs the Italian Banking System-economy.

  7. Mike Earussi says:

    When you borrow money in a currency you don’t control this invariably happens.

    The U.S borrows in it’s own currency and so can print it’s way out of debt if it has to (at the risk of massive inflation), but Italy doesn’t have this option.

    This, of course, is not just an Italian problem but also every country who has done the same thing–in Latin America it’s mostly in U.S.

    Once the world economy slows down again it’s easy to see a massive default coming in every poorer country who has done this which will just further exacerbate the recession. There’s nothing new in this as this kind of default cycle has been going on for over a century it’s just that each new generation of lenders forgets lessons supposedly learned from the past. The world will always recover, its just how much pain we have to go through before it does that’s the question.

    • nick kelly says:

      There are very few countries that can borrow EXTERNALLY in their own currency. An Italy that returned to the lira would not be one of them.

      The lira was well on the way to irrelevance before the euro. Large purchases like real estate were priced in dollars. Just before the euro, Italy issued a 10,000 lira note.

      To quote the late, great, Sergio M, savior of Chrysler and head of FCA: ‘unless Italy can adapt to more resemble the rest of the industrialized world, Fiat may have to leave’.

  8. Auld Kodjer says:

    I used to work for a global firm with a head office in the US and satellite offices in most European countries.

    Occasionally a directive would by head office to all countries about the need to change some business practice.

    The Germans would immediately respond with a 4 page memo of bullet points outlining why the directive was illogical and based on inferior thinking.

    The French would ignore the directive unless it was written in French.

    The British would argue relentlessly for 3 months about how the directive wouldn’t work in the “different” UK, but nevertheless adopt it and follow it like good corporate citizens.

    The Italians would smile, respond with an enthusiastic “buona”… then completely ignore the directive and carry on as usual.

    [Now that I have offended everyone], the lesson from this story is that the Eurozone will never, ever operate in harmony … and that Brussels is a misconception wrapped in delusion inside a fallacy.

    • nick kelly says:

      Kind of like a union of Texas , Utah, California and Arkansas.

      And a federal AG (Sessions) who wants to enforce the federal ban on pot,
      on the states like Oregon where tractors plow fields of pot.

      Alaska de facto seceded 20 years ago. (Palin’s hubby, as the McCain team only found after nominating her, was a member of the Alaska Independence Party)

      It won’t be the last.

      • Frozen Man says:

        Alaska seceded? Hardly. Alaska is the land of redneck socialism and 61.3 percent federal ownership of lands. We roll in the federal dollars, we pay no taxes and complain when the government only gives us half of our annual free money check because that 1,600 bucks is almost as bad as paying taxes! Government services should be free, right? We’re not going anywhere.

    • Steve clayton says:

      Hi Auld Kodjer, as a Brit this is absolutely spot on. Truthfully we adopt the directive then change it slightly. Ironically we’re probably the country that has followed the EU rulebook the most, other countries just pretend to.

    • fajensen says:

      [Now that I have offended everyone], the lesson from this story is that the Eurozone will never, ever operate in harmony

      Nor should it!

      It has been noted that the ugliest cities in Sweden are those where the Social Democrats had enough votes to rule unchallenged -> “Harmony”, leading to concrete-constructions being shat over all of the ruins of the old parts of town, where now nobody wants to live or even visit.

      The most beautiful cities are those where there were no solid political majority possible and the fights, discussions and arguments never ends.

      We need diversity and disagreement to prevent a hard optimisation towards whatever long-term stupid “visions” or mono-cultures that the current crop of leadership / central planners / technocrats are cooking up for us.

      Too often great visionary projects turn out to be evolutionary dead ends and those sad ideas that everyone agrees with are probably not very creative nor useful!

      Besides, the US has wider cultural differences between states than the EU has and yet, it sort of worked for 200 years.

      In Denmark people think everything coming from “America” is generally going to be something stupid that does not make sense. We know from experience that it will eventually somehow be forced upon us anyway after the usual delay of sometimes many years, so we don’t waste any efforts arguing against it. We prefer to ignore it until it cannot be routed around any longer, then we change jobs or retire.

      Chinese leadership is probably preferred by the Danes. They are “hands-off” technical people and they don’t care about the details as long as the numbers are what they expect. In contrast, American “leaders” always have to prove their authority by imposing Americanisms, whatever the numbers are. Conformity is their key KPI.

  9. hotairmail says:

    The Euro is the new Gold Standard. And I don’t mean that in a good way.

    France persuaded and fooled the Germans to enter the Euro at a very advantageous rate to France who low balled their own entry rate, playing on the Germans’ pride in a strong currency. Then under Gerhard Schroder and every year since, the Germans have got together with their national unions and corporations and deflated their way to competitiveness for Germany. So now we have the position of the lesser nations (increasingly including France as we move forward) who entered the Euro on competitive terms falling ruinously behind. They now have to deflate their way to competitiveness, even as year in, year out Germany turns turns the screw on its own cost base. They will never catch up whilst they are still in the Euro.

    The best they can hope for is that their trade outside the Eurozone goes into large surpluses….which is what Italy et al are doing. How long will others accept that mercantilist policy? And how long until the Eurozone members accept that such a currency zone as being futile…in that it encourages trade outside the Eurozone.

  10. R Davis says:

    “contagion was definitely contains”
    They are all like a herd of cattle, any little thing will spook them & they will stampede.”

    Austerity is a loser’s game –
    And the EU banks do not know this.
    They are merely debt collection agencies.
    How long can this stagnation go on before it all falls apart.
    The herd will stampede sooner or later.

  11. MCH says:

    So, the basic premise here is that the Italians have the EU by the balls. Sure, it’s a bit of a mutual suicide pact, but what the heck, the Italians are basically saying, if the EU doesn’t blink, it’ll start the ball rolling on the next big collapse. Starting with the French, Spanish, and then eventually when those guys fold, the Germans will get hosed too.

    Ha ha, the EU is turning out exactly like some genius prognosticator I heard years ago. Its basic rules were put in place by the French who figured they didn’t have to play by those rules, but run by the German technocrats that want to enforce every rule that gets put in place.

    • MC01 says:

      Italy has nobody “by the balls”. The government is like a gambler whose hand consists of a queen of hearts, a six of diamonds, a four of clubs, a two of spades and the instructions for pinochle acting like he’s Bret Maverick from the TV series.
      Unfortunately, the gambler the other side of the table seems to be the very description of a paper tiger: it roars, it bares its fangs but ultimately it’s somewhere between harmless and pathetic.

      This “showdown” is all about Italy throwing a massive temper tantrum to get the ECB to let the taps to flow freely for all eternity. “Hangover” by Tayo Cruz is a perfectly apt metaphor, especially the verse “… and I don’t ever ever want to grow up”.

      • Julian says:

        FYI – it’s Taio with an “i”.

        In addition, you’re wrong on another point. Italy does have the EU by the balls.

        In case you haven’t realised there’s an EU Election next year – next May to be precise.

        If Italy’s economy goes pear-shaped – and pulls the entire Eurozone down with it in the first half of 2019 – who do you think will get the blame for this?

        I’ll give you a tip – it won’t be the parties represented by the likes of Salvini, Di Maio, Le Pen, Orban, Kurz et al. No, they won’t get the blame.

        The folks who will get the blame are those named Juncker, Tusk, Draghi and those associated with Merkel & Macron.

        Yes – the so-called “Centrists” will get the blame from any confrontation between Italy and the EU/ECB in the run-up to the May 2019 EU Election.

        Why do you think Italy are engaged in a game of brinkmanship right now? It’s because they know they have the EU/ECB by the balls, and they are going to spend the next 6 months squeezing until they get what they want – whatever that is.

        After the May Elections they lose their leverage to some extent – though if their gambit goes well they sweep many of these traditionally centrist parties out of the EU Parliament and those who come along to replace Juncker, Tusk & Draghi are more naturally in alignment with what the likes of Salvini & Di Maio want.

        Watch the game being played and don’t fall into the trap of thinking Italy will back down anytime soon.

        They won’t. Why should they?

        • fajensen says:

          Obviously Brexit will get the blame.

          Meaning the Italian government doesn’t have six months before “the market” blows up a couple of their most stupid banks (and the non-Italian side of that mess gets some kind of covering over “the unique situation that no one could possibly predict.”).

          The Italians are plain silly if they believe that the other nationalists cares about Italy.

      • MCH says:

        Nice analogy, but if that’s really the case, why isn’t the EU just calling out Italy’s bluff? I still go with the theory that this is some weird mutual suicide pact that has been established, the only question is who is going to blink first. For the centrists, they main problem is if they let Italy crash and burn, it might take down the French banks. And that’s probably some kind of red line for somebody.

  12. rd says:

    The French banks are critical to the global network of Primary Dealers that collectively conjure the USD$ credit surface. Throw in a FED draining reserves (available to arb-fund FX swaps) and the Brexit and you have all the ingredients of a nasty “turn” at the end of Q4 as dealers window dress balance sheets for BASEL compliance.

    The USD$ funding crisis is on the way, (and China is a bigger player than many think).

    the unwind in structured product like CLOs and CMBS–that depend on AAA FX hedged buying in Japan–is going to be EPIC.

  13. Leser says:

    Great article and equally the comments.

    I have doubts about the original premise though that their ownership of Italian bonds would pose any real danger for the French and other EU banks. The situation is not the same as 2011 during the Greece crisis, the rules have been changed much to the favour of the banks such that they can’t lose holding these bonds – in order to stabilise the yields.

    I believe the banks don’t have to mark-to-market their govt bonds, neither do they have to post any meaningful collateral. If push comes to shove, the ECB increases/extends their bond buying to absorb any selling. Though absent any major panic, it’s unclear who would want to sell given the favourable conditions of owning these bonds. As the author says, the banks get to collect risk-free yield.

    The ECB is aligned with the Fed. The goal is to prevent a blow-out of yields and ensuing collapse of the whole house of cards as rates are being hiked (a little and ever so slowly).

  14. Emiliano says:

    The truth is that they are using every possible tool to remove the current government from office. In 2011 they succeeded with Berlusconi. This time is different. There’s a new government with balls now, who thinks that the best case scenario will be Italy leaving the Eurozone. It may cause pain in the short term, but will free and resurrect the country’s economy in the long run. If you don’t understand the changed political scenario, you can’t realize how far they’re willing to go with their allies turned enemies.

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