I find it strange that when I talk to my most fervent Brexiteer friends and colleagues, they seem to be almost salivating over the prospects of Italy jamming it to Brussels – and the Italian banks bringing down the Euro. The word Schadenfreude springs to mind. But I also think there’s a deadly mixture of wish fulfillment and overly economic thinking going on. I’m sure there are Eurosceptic forces on the move in Italy and I don’t doubt that there will be many more bust-ups over economics, debt and currency in Europe over the next year or so, but the reason that most Italians want to stay in the EU and the Euro is cultural, historical, social…in fact, most things that are not economic. Which doesn’t, of course, mean that a banking crisis in Italy might not do cause irreparable damage to the Euro project – Italy in crisis would clearly be a major problem for the ECB.

My other small gripe is that it’s quite hard to get some hard numbers of what is going on Italy and its banks. My overall impression is that the Italian banking sector is actually in fairly decent shape, with strong balance sheets, lots of tier 1 capital (13.6%0 and much lower levels of nonperforming assets. But there are clearly some very localized problems, and a few weeks ago Bath-based risk consulting house Check risk brought out an excellent note which pinpointed the specific banks of concern – and lavishly lays out the hard numbers behind the potential crisis. The report identifies the following as names to worry about: Banca Monte dei Paschi, Banco BPM, Credito Valtellinese and Union di Banche Italiane. The contagion effect of these banks is also obvious – they have significant exposure to Italian sovereign bonds.

“Our analysis of key banks indicates that there are signs that they are under pressure and should be monitored carefully…in particular, Credito Valtellinese and Banco BPM which “have a distance-to-distress of 1.7 and 1.8 respectively which translates to approximately a 1/5000 chance of becoming distressed tomorrow. Another detail of concern is that Credito Valtellinese is also extremely sensitive to overall market movements indicating its distance-to-distress could rapidly decline in an increasingly turbulent environment.”

Clearly if these banks did crash and burn, the impact on the wider banking system in Europe could be huge : the Check risk report lists the following banks as most sensitive to a 5% or worse distress event in Italian banking: Societe Generale, HSBC, Aareal, Lloyd, BBVA, ING, RBS, UBS, Standard Chartered, Bank of Ireland and Danske Bank. But we also need to be cognizant that these risks may not materialize into a worst-case scenario.

“It should be noted that they are all well capitalized as indicated by their distance-to-distress and their Tier 1 Capital ratios. However, should these banks begin to be impacted it would provide an indicator of contagion and problems spreading throughout the system. The criticality score provided provides an indication of the knock-on effect with 1 being the most critical. Note that a 1 does not mean it is the most critical bank to the banking system but that a significant decline in the distance-to-distress of this bank is indicative of a broader problem. In this case, RBS, Lloyds, ING, Societe Generale, and Bank of Ireland provide good indicators of contagion and its spread.”

What unites cynical Brexiteers and those of simply worried about Italy, is that the ECB and the wider European financial governance system needs large scale reform. According to CheckRisk, the ECB needs to provide a new repo facility to help recapitalize the banks while the politicians need to come to a sensible long-term arrangement.  But one concern keeps lingering in the back of my mind – Italy and France really can’t afford to fall out too badly at the political level. Macron may despise Italian populists but guess which country is most on the hook if Italy does go pear-shaped? Maybe the creditors might want to talk a bit more to their debtors…According to CheckRisk “the main connections for Italy to the EU are via French banks and more widely under the Target2 payments system to Germany. European banks hold 425bn of Italian debt. France holds a massive €285.5bn and it is thus no surprise that Franco-Italian relationships have deteriorated so rapidly. It is also important to note that the ESM (European Safety Mechanism) would be swamped by an Italian banking crisis at present”.