MNI SOURCES: EU Could Hold Up Italy Grants, Bank Concerns Grow

European finance ministers could threaten Italy with more rigorous vetting of bank rescues and maybe even dragging out approvals of grants from its new EUR672.5 billion Covid recovery fund unless it finds a way to overcome domestic opposition and approve an overhaul of Europe's bailout fund, sources told MNI.

Whilst officials would be keen to avoid such an escalation, ministers are increasingly convinced of the pressing need to implement the reform of the European Stability Mechanism and to approve an ESM backstop for the Single Resolution Fund, which would double its EUR60 billion firepower and is central to plans for implementing European Banking Union, by the end of the year.

Growing concerns over the likely state of some of Europe's banks following the pandemic are feeding a new sense of urgency, officials said. Italy's continuing opposition is particularly rankling with ministers in light of what they perceive to have been the solidarity with the country shown by the rest of the EU at the June summit which approved the Recovery and Resilience Fund.

"The EU will have to push back on this (Italian opposition). Any further progress on banking union is impossible without reform of the ESM Treaty," one senior official with a European finance ministry said.

ITALIAN DEADLOCK

EU ministers and leaders agreed the draft text of the ESM Treaty reform in June last year but it must be ratified in national legislatures, and approval in Italy's parliament has been blocked by opposition from the populist Five-Star Movement, which shares the country's governing coalition.

The EU's aspiration was and remains to give the SRF's reinforced backstop an early start before its latest and default start date of 2024. But now many European officials believe they are running out of time and that if they cannot get a deal agreed by the end of 2021, allowing the backstop to start in 2022, there may not be much point.

"All (EU finance) ministers agree that Banking Union is a priority, so we have to get this done," said another EU source.

One source described the debate in Italy as having become "quite irrational" and "disconnected from the reality" of what the backstop is meant to achieve, which could include assisting Italy's own banking system.

"I don't think that the bank sector is fragile, but one or another banks could have a problem if the recession is protracted, or if there is a negative rating action or we have an elevated level of insolvencies over the next six-12 months," said the finance ministry official.

"Given everything that is going on with Covid and in the economy, the need for [the backstop] is now even more pronounced," one EU source said.

CONCERNS OVER BANKS

Officials believe many banks face potential solvency issues when Covid moratoria on debt expire and corporate insolvency procedures fully restart.

But another source familiar with the talks was more sceptical about what could be done.

"Yes, they want to solve it by the end of the year, but how can you force a country to change their mind if they disagree? … Basically, we want to help Italy overcome the internal opposition to the ESM reform plan," the source said.

The same source thought the EU might have to offer Italy assurances that no further risk reduction measures would be required of them in order to make progress while another said a deal by the end of the year remained possible.

For the moment, EU officials will be keeping a close eye on upcoming Italian regional elections, hoping that political resistance to the ESM may ease if the Five-Star and the right-wing League fare badly relative to the centre-left Democratic Party, which shares the governing coalition.

A sound performance by the Democratic Party would make it easier for the government to push for the ESM backstop, which Italian Finance Minister Roberto Gualtieri has called a "positive" reform and which is less politically sensitive than any potential use of ESM credit lines.

--Additional reporting by Giada Zampano in Rome.