AFTER years of economic stagnation and questionable lending, bad loans at Italian banks have piled up. The gross value of non-performing loans (NPLs) is around €360 billion ($406 billion), or almost one-fifth of Italian GDP. Hasty repairs and rescues have been arranged for troubled lenders—notably Monte dei Paschi di Siena, the third-biggest, in July. But what can be done about the loan mountain?

The IMF has suggested building a robust market in NPLs, thus placing the burden of bad loans with distressed-debt specialists, freeing Italian banks to provide more credit to the real economy. But although the market for bad debts has started to pick up in Italy, with volumes increasing steadily to reach €22 billion so far this year, structural obstacles mean such markets may be less successful than in other European countries.

Distressed-debt investors tend to buy loans in bulk, and hence prefer loans with easily recoverable, tangible collateral. The NPLs of stricken British, Irish and Spanish banks in recent years were largely mortgages: being backed by property, they could be valued from current real-estate prices. British and Irish...Continue reading