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10 April 2019 Fiscal problems in Italy have rekindled fears associated with the risky link between sovereign debt and the financial sector in the euro area, a link at the center of the 2011-12 crisis. The International Monetary Fund supports this in its Global Financial Stability Report. "There is still a risk that the link between sovereign debt and the financial sector may be strengthened," explains the Washington institute, listing the main channels through which that link could return to worry. The first channel is of a financial nature and is associated with the losses suffered by banks and insurance groups through the bonds in their possession. On this front, the Fund explains that in Italy - as in Spain, Portugal and Belgium - national government bonds in banks' portfolios are many compared to the assets of a given country. This does nothing but increase exposure to sovereign bonds, especially if the sovereign rating is cut.

For insurance companies, the Fund estimates that groups in the euro area have over 15% of sovereign bonds in circulation in the euro area, slightly less than banks, and almost 25% of bonds issued by eurozone banks. The second channel is of a macro-financial type, in which sovereign and financial shocks reach companies and families through slowing growth and higher rates. The Fund explains that this channel is activated in the long term and could trigger two other channels of contagion: another increase in non-performing loans on banks' balance sheets and a reduction in tax revenue. Then there is the risk that banks will pass on rising financing costs to customers by raising interest rates on mortgages. "However, until now there is no evidence of such a rise, perhaps thanks to the liquidity of the European central bank."

The IMF, however, warns: financing problems for banks could worsen if a nation's rating is brought under investment grade by all four major rating agencies. The reason? The sovereign bonds of that nation could no longer be used as a collateral by the central banks according to the current rules ". The third channel concerns the falling demand for bonds. If the banks suffer losses or if the ratings of sovereign bonds have been reduced, banks and insurance groups may not be able or willing to buy those bonds, the IMF observes. "Such a drop in demand could put yields under additional pressure, increasing financing costs and losses even further." , the Fund maintains, we need to continue to reduce non-performing loans.

Possible scenarios
The Fund then simulates two scenarios, a sweeter one and a more real one, to try to see if and how the euro area banks are prepared for possible sovereign debt shocks. In the harshest scenario, the one with a strong jump in sovereign yields, banks in Italy, Portugal and Spain would register significant losses. In the milder scenario, with a non-dramatic increase in yields, the Tier 1 capital ratios of the European banks would be higher than those of 2010 thanks to the increased capital allocated and to the accumulated reserves. Insurance companies could also experience significant losses in the event of sovereign shocks, and this is because euro area insurance companies control 15% of Euroland's sovereign bonds, and about 25% of euro-area bank bonds.

High spread in Italy, weight for growth and contagion risk in the Euro area
"In Italy, long sovereign spreads could weigh on growth and on the fiscal and banking prospects, while a new stress exerted by a jump in costs to finance could affect other countries in the region". This is the warning issued by the Fund in its Fiscal Monitor. The Fund pointed out that in our country, the spreads in the second half of 2018 rose but the contagion effect in the other economies of the Euro Area with high levels of debt was "limited".

In Italy it could serve "modern tax" on first home
The International Monetary Fund also claims that in Italy "assets could be taxed through a modern tax on primary residences". This is what is reported in the Fiscal Monitor, the report published today in the context of the Washington Institute's spring works.