European banking stocks enjoyed a lift this week as fears about stress in the sector receded in the wake of Italy cobbling together a rescue package for its weakest lenders, averting a potential systemic failure.

Shares in Europe’s banks have plunged this year as investors fret over the impact of negative interest rates and squeezed margins. Italy’s banks have been among the hardest hit as they are saddled with a high proportion of bad debt.

Italy’s deal for bad loans fuelled a broad rally for European banks, but whether the sector is really turning a corner, or whether there is yet more trouble to come, is another matter.


Italy Rescue Deal

Italy’s strongest banks are to create a government-backed fund of around €5 billion to rescue the weaker members of the sector.

UniCredit, Intesa Sanpaolo and UBI Banca will be the main contributors, while the government will in return reform the country’s outdated bankruptcy laws.

Italy’s financial sector is weighted down by around €360 billion in bad loans –around a third of the eurozone’s total. The fund will hoover up unsold shares from cash calls at a number of smaller banks.

Officials say the vehicle won’t fall foul of EU laws on state aid and are playing down suggestions that the fund will increase systemic risk by storing up trouble for later. But kicking the can down the road is hardly a new thing for the European banking sector, let’s be honest.

Negative Rates Weigh

Across the European banking sector, the damage wrought by the ECB’s expansionary monetary policy is being felt. A combination of slackening profits and negative interest rates saw a big selloff in the first quarter. The Stoxx Europe 600 Banks Index posted seven straight weekly declines at the start of the year before a turnaround in mid-February.

In addition to negative rates squeezing margins, banks are still struggling with increased regulation and higher capital requirements. For all the respite offered by the rescue package for Italy’s banks, there is a lot of capital still to be raised.

ECB, Earnings in Focus

Trading in European banking stocks is likely to get more intriguing as we hit earnings season. After the big US banks report, European banking stocks follow suit over the next few weeks.

Ahead of this, the ECB’s meeting on Thursday, April 21st, is going to be closely watched for any signs the bank is ready to push rates further into negative territory, even if no one thinks there is a bottomless pit of NIRP benefits.

Increasing doubts about the efficacy of negative rates mean there is a bright spot on the monetary policy horizon, but with even Jens Weidman, the Bundesbank chief, coming to the defence of ECB boss Mario Draghi, it seems that negative rates are not about to vanish from the ECB’s agenda any  time soon.

For banks that means continued pressure on margins. For now they’ve not passed the cost on to depositors, but that may also change if NIRP persists.