EU to face big problems in Italy and Spain after Cyprus bailout

EU to face big problems in Italy and Spain after Cyprus bailout
The eurozone could face a new heap of financial problems in Italy and Spain, as small businesses fail to repay bank loans. 

While Cyprus accounts for just 0.02% of the eurozone’s economy, Italy and Spain account for 28% of it. Keeping the countries’ banks afloat is the key priority for them both to pull out of the crisis, Reuters reports.

Small and medium-sized companies provide most jobs in Italy and Spain. Their inability to repay debt would put the two countries at the heart of Europe's economic crisis.

"You can be sure that if these companies' bad debts rise, you're going to see more bad loans to families, and credit card bills that won't be paid," Javier Santoma, Professor at Spain's IESE business school told Reuters.

Profits at Spain’s banks have been steeply declined. According to Reuters, profits in Spain's three biggest lenders Santander, BBVA and Caixabank fell an average 60% in 2012 after the government forced provisions for property losses. The growing number of bad loans leaves banks with no other choice by calling for government help. 

Spain’s deep property market problems have also caused multi-billion euro losses to three small banks. Banco CEISS, BMN and Caja 3 have all been rescued by the government and had to take big write-downs on bad property loans and assets.

So far Italy's financial system has proven resistant, however the ongoing recession is still a major threat to its banking sector, the International Monetary Fund said on Tuesday. 

"The Italian financial system has shown remarkable resilience in the face of a severe and prolonged recession at home and a major crisis in Europe," the IMF report said. However, “while stabilized, the Italian financial system is not immune from risks: continuing weakness in the real economy and the link between the financial sector and the sovereign remain key risks."

Italian banks set aside more funds for bad loans and created a market to deal with bad assets. Italy’s biggest banks Intesa Sanpaolo and UniCredit allotted a combined €14 billion in 2012 to cover bad loans. 

The way the banking sector crisis has been handled in Cyprus with the EU-IMF bailout and massive haircuts of large depositors also raised concerns over banks in other debt-burdened eurozone countries. Their sovereign ratings also faced more pressure indicating that policy makers are overestimating their ability to contain the crisis, Moody's told Reuters.

"Policy makers appear very confident that market conditions are benign enough and that they have the tools to avoid contagion to other peripheral economies and their banking systems," Bart Oosterveld, managing director of sovereign risk at Moody's, told Reuters. "We think that that confidence may well be misplaced."

Cyprus is now considering the pros and cons of quitting the Eurozone if the price paid for the EU-IMF €10 billion bailout proves too high. Moody’s has lowered Cyprus’ credit rating to ‘Caa2,’ as the risk of Cyprus exiting the eurozone has only increased. The outlook for Cypriot government bonds rating remains ‘negative.’

Analysts fear that Cyprus set a dangerous precedent for the future rescue efforts in other eurozone countries. This may prompt runs on banks as depositors fear for the safety of their money.

The Organization for Economic Co-operation and Development (OECD) said on Thursday that no meaningful recovery will be seen in the eurozone until at least the second half of next year. It also warned of the risk of asset-price bubbles emerging in the single-currency zone, the Financial Times said. A surge in equity and bond prices across the G7 remains unjustified by countries’ economic performance, the OECD said.