Shares of Banca Monte dei Paschi di Siena (BMPS) tumbled on Monday and declined more than 19 percent on Tuesday. Trade was halted at times, according to Reuters. This came after the European Central Bank told BMPS on Monday it must cut the bad loans on its books by 2018. BMPS is believed to be the oldest bank in the world and is one of Italy's largest financial institutions.
Italy's Ubi Banca and Unicredit pared Monday's sharp losses on Tuesday, while Banca Popolare dell'Emilia Romagna closed roughly flat.
"The fact is, the Italian government is up the proverbial creek without a paddle with its banks, unable to bail them out and stuck with a portfolio of up to 360 billion euros ($400 billion) of non-performing loans that are strangling the life out of the Italian economy," Michael Hewson, chief market analyst at CMC Markets, said in a Tuesday note.
"Of those loans, (BMPS) it is estimated, has about 48 billion euros worth, and with a market capitalization of about 1 billion euros, it's not hard to see where its problems lie," he added.
The U.K.'s Brexit referendum has injected greater uncertainty into European growth forecasts, including Italy's. That in turn has created worries about higher loan losses at the country's banks, coupled with falling government bond yields that further hurt financial institutions' margins.
EU banking union rules are designed to shift losses on to shareholders, bondholders and large depositors rather than taxpayers in the event of another financial crisis like the one experienced in 2008, when taxpayers in some countries bore the brunt of collapsing banks having to be rescued by national governments.
Italy's banking system is considered to be one of the most vulnerable in the euro zone with a high level of non-performing loans (NPLs) — estimated to total 360 billion euros ($400.7 billion) — overshadowing the sector.
Societe Generale's global research analysts led by Patrick Legland noted on Monday that Italy's somewhat sclerotic banking system was "still fragile," facing "specific headwinds related to the disposal of their NPL market, while bankruptcy processes and time for repossessions deter investors."