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French, Spanish banks most exposed to Italian bonds outside Italy

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French, Spanish banks most exposed to Italian bonds outside Italy

French banks are most exposed to Italian sovereign debt outside of Italy itself, data shows, as a populist-far right coalition heads for power, unsettling bond markets.

Lenders based in France held €44.27 billion in Italian bonds, second only to the €188.76 billion on the books of Italian banks themselves, according to data from the European Banking Authority's 2017 transparency exercise. Spanish banks had €28.75 billion.

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The most exposed non-Italian banks were France's BNP Paribas SA and Belgium's Dexia SA, with €16.02 billion and €14.78 billion, respectively, figures released by the European Banking Authority in June 2017 show. Spain's Banco de Sabadell SA, meanwhile, held €10.47 billion.

Fears over a government coalition between the populist Five Star Movement and the far-right League have triggered a steep selloff in Italian bonds, pushing the yield spread versus benchmark German Bunds to the highest level since October. Italy's 10-year bonds fell May 18, sending the yield 11 basis points higher to 2.226%, as the two parties published a draft policy agreement including drastic cuts in income tax, a €780 a month basic income for those in need, and a call for EU treaties limiting fiscal deficits to be renegotiated.

"Italy's high stock of debt raises the question whether fiscal expansion threatens Italian debt dynamics," UBS analysts wrote in a note May 18. They added that any expansion of spending equivalent to more than 1% of GDP, which would be far below what the two parties are promising, would strain the market's tolerance. "This is because Italy will have to tackle a higher debt ratio at the time of the next cyclical downturn."

Yet so far, despite euroskeptic rhetoric from both Five Star and the League, the two parties' rise to power has not been perceived by investors as a threat to the eurozone as a whole, RBI analysts said. Earlier calls for a referendum on membership in the euro were missing from the draft policy platform, which was being put to a vote of Five Star members May 18.

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But the risk premium on Italian bonds is likely to increase further in the coming months and could lead to overspills into neighboring countries, RBI said.

"The situation could only become crisis-like in the short term if the political crisis in Italy actually takes on a systemic character. Then the positive balance in the euro government bond market could break and lead to an increasing spiral of higher risk premiums. This would be conceivable, for example, with a concrete perspective of a referendum on the withdrawal from the euro. However, we consider this scenario unlikely in the foreseeable future."

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