Italy's banks have concerned investors for several years due to the high volume of NPLs on their balance sheets, estimated to be worth 360 billion euros ($396 billion). Italy is currently negotiating with its European partners over how to recapitalize its banking sector. New European banking rules require depositors to be "bailed-in" to any bank rescues, but the Italian state may want to use public finances – breaching EU rules.
Italy's political scene looks vulnerable too.
Prime Minister Matteo Renzi has staked his leadership on a referendum on constitutional reform in October. The vote is aimed at reforming the Italian Senate and breaking the persistent deadlock between the lower and upper houses of parliament that has made lawmaking and reform a difficult process.
Renzi has said he will resign if the referendum fails, leading to a leadership vacuum that may prove reminiscent of the U.K. following its vote to leave the European Union.
Italy has seen three prime ministers in the last three-and-a-half years and the rapid change of leadership has hampered attempts to reform its economy.
On Monday, the IMF praised the Italian authorities for embarking on what it called "a range of very important reforms, including institutional, public administration, fiscal, labor market, and banking sector reforms" and said it was "imperative that these efforts are fully carried out and deepened."
"Taking advantage of the start of economic recovery and the current favorable tailwinds of monetary easing, low commodity prices and fiscal support, the timely implementation of complementary and mutually reinforcing efforts in the financial and fiscal sectors and structural measures would help boost growth, lower the upfront cost of reforms, and accelerate the building of buffers," it said.
The IMF's directors underscored that financial sector reforms "are critical to entrench financial stability and support the recovery."
"To substantially reduce the stock of NPLs over the medium term, lower the cost of risk, and improve operating efficiency, (the fund's directors) supported further measures, including more intensive use of out-of-court debt restructuring mechanisms; strengthened supervision; and a systematic assessment of asset quality for banks not already subject to the ECB (European Central Bank) comprehensive assessment, with follow-up actions in line with regulatory requirements."
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