Bank of Italy tells banks to up bad debt coverage after audit

The Bank of Italy has told some of Italy's biggest banks to hike bad loans provisions after a sector audit showed they were vulnerable to defaults from small firms struggling in a deep recession, two senior banking sources told Reuters. The central bank issued the instructions after conducting confidential inspections lasting two to three months at 20-30 large listed and unlisted banks, both sources said.
With Italian banks staring to report earnings this week, the level of their coverage of non-performing loans is set to take central stage as the country faces another year of contraction. The central bank has warned institutions against issuing dividends - the main source of revenues for a myriad of banking foundations that own stakes in Italian banks - if their Tier 1 capital ratio is below the 8 percent minimum level, one of the sources said.
The Bank of Italy declined to comment. "The Bank of Italy is drafting new guidelines (on NPLs coverage). With this exercise, the bar is set higher, towards a level that looks like a more reasonable benchmark for the system," said one of the sources, who did not give more details about the new central bank requirements. The second source confirmed the audit took place and that the central bank was asking Italian lenders to put aside more provisions against bad loans.
"Depending on the bank, the exercise has led to some rigorous corrections," said one of the two sources. Banking analysts have singled out rising bad debts, mostly due to small companies struggling to pay back loans, as the biggest risk for the banking system. The soundness of the country's real estate sector is also being questioned, even though Italy does not face a Spanish-style property crisis. The sources said the central bank has told banks to be more rigorous when assessing the value of real estate assets, which do not always reflect the fall in real estate market prices.
Total gross bad loans rose to 125 billion euros in Italy at the end of 2012, up 16.6 percent from a year earlier, data from banking association ABI showed last month. ABI expects the growth rate of bad loans, which totalled just under 78 billion euros two years ago, to peak in the first half of this year. At 40 percent, Italian banks' coverage of doubtful loans is well below the European average of 53 percent and a 60 percent coverage for Spanish banks, Mediobanca Securities analysts say, adding that they see scope for 21 billion euros of additional loan-loss coverage in the sector.