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Italian Banks' Situation Improving: Analysts

The beleaguered Italian banking sector is gradually improving, with asset quality and capital ratios getting better, according to analysts at Citigroup.

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Italy's economy, the third largest in the euro zone, has come sharply into focus this month after public bickering in the Italian government and fears that financial trouble in Greece could spread to Italy.

Shares in Italian banks have plummeted and Italian bond yields have hit their highest level since the euro was introduced. UniCredit , the country's biggest bank, was forced to suspend trading in its shares briefly earlier this week as the price hit limit down.

The country has a 1.8 trillion euros ($2.6 trillion) debt pile, with one of the highest debt to gross domestic product ratios in the euro zone, and needs to refinance more than 100 billion euros worth of debt before the end of September.

However, long-term value is emerging in its banking sector as new reforms are enacted and early signs of economic improvement emerge, Azzurra Guelfi, banking analyst at Citi , believes.

"The key trends still show pressure on NII (Net Interest Income) margins given the sovereign situation, but asset quality is slowly improving, cost control is still a focus and capital has improved," she wrote.

"There are some signals of economic improvement in some areas of the country (North) and export-related data are improving as well," Guelfi added.

Lending has grown by around six percent year-on-year, driven by an improving corporate sector.

"Larger banks so far have shown minimal increases versus more aggressive smaller players," according to Guelfi.

Pending reforms include a revision of the usury rate calculation, which should help banks to better price risk, and changes to taxes on bonds and securities portfolios.

Staff costs could rise by less than in previous years with the renewal of the labor contract.

Italy has relatively high levels of household saving, and did not have a property bubble in the way that other euro zone countries such as Ireland and Spain did.

Still, the cost of funding is rising with the widening of Italian spreads, which means that the cost of both wholesale and retail funding has increased.

"Consensus earnings could remain under pressure, mostly due to funding," Guelfi said.

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