Shares of Italy's most beleaguered lender, Monte dei Paschi (BMDPF) , fell on Monday after Germany's central bank used its monthly report to call for more influence for eurozone government representatives over the terms of banking sector bailouts.
The prospect of more active German involvement in the bailout process will worry the Italian government, which is currently attempting to win leeway from European Union state aid rules. It's also bad news for Italian banks including Monte dei Paschi, which recently received a European Central Bank order to cut its bad loans.
Monte dei Paschi shares have lost more than 70% of their value so far this year. They were trading down 2.5% at €0.33 (36 cents) on Monday afternoon, having earlier fallen by as much as 3%.
On Friday Moody's downgraded Monte dei Paschi's credit rating. The agency cut the baseline credit assessment rating by two notches to CA, which is one notch above default, before placing two more of the bank's credit ratings under review for downgrade.
The agency cited Monte dei Paschi's capital shortfall and the challenges it will have trying to fill this gap with funding from capital markets.
Monte dei Paschi is widely believed to have the most exposure to non-performing loans out of all of Italy's banks and the ECB has ordered it to reduce the share of bad loans, as a percentage of assets, to 20% by 2018. The current level is more than 30%.
Italian authorities, meanwhile, are trying to work out how they can bail out the nation's banks without forcing losses on private investors, a move which has already been dismissed by German Chancellor Angela Merkel and one that is prohibited under European Union regulations.
At present, bailout terms are set by the European Commission, the ECB and any international partners involved, such as the IMF.
However, the Bundesbank said in its July report that eurozone finance ministers should have a greater role in establishing the terms of any future bailouts.
The Bundesbank also calls for more of the monitoring and enforcement work to be put into the hands of euro-area government representatives. Eurozone finance ministers already administer disbursements from the European Stability Mechanism, or ESM, which is a collective rescue pool, but they do not have any power to set the terms of any rescue deal.
Any bailout that would allow private investors in Italian banks to go unscathed would be politically toxic in Germany, given the nation's conservative fiscal stance and the fact that it is the largest contributor to the ESM bank rescue fund.
However, any move to bail-in private investors during the process would also be politically contentious in Italy, given the controversy caused by several earlier rescues, the weak standing of the Italian government and a pending referendum on constitutional reform.
In Italy, the vote on constitutional changes isn't due to take place until October but already, it has effectively been made a referendum on the current leadership of the country since Matteo Renzi has pledged to step down if he cannot secure a vote in favor of reform.