Italian banking stocks led the main European index lower on Monday as fears continued to mount over how the struggling sector could cope with a No vote in Sunday's referendum.
Italian Prime Minister Matteo Renzi has effectively staked his political career on securing popular approval for his government's aim to proceed with what many believe are long overdue constitutional reforms. However, indications that Renzi's side is lagging in the latest polls has upped jitters that the banking industry might not be able to fix its deep-seated problems if there is a change of government after the referendum.
According to Antonin Jullier, global head of equity trading strategy at Citi, such uncertainty is precisely what the country's banking index – which has lost around half of its value so far in 2016 – does not need.
In an email to CNBC Jullier said, "The market needs to feel comfortable that there is a degree of stability in Italian politics, in particular a good chance of reforms being passed and the budget being delivered."
"This stability would form the basis for a more stable platform to establish the clearing price for capital-raisings in the sector," he added, breaking down what equity investors are looking for in order to prompt a positive reversal in sentiment.
Meantime, spreads on 10-year Italian government bonds continued to trade in the elevated range to which they jumped on Friday, just shy of 190 basis points above their German bund equivalents by early Monday afternoon in Europe. The level represents the highest divergence between these bond counterparts in over two years.
The ugly numbers propping up Italy's banking sector reveal around 360 billion euros ($381 billion) of non-performing loans (NPL) compared to only 225 euros billion of book value equity.
Repeated attempts throughout the year by certain banks to shore up their capital structures, in conjunction with a spate of government initiatives, have met with middling success and have failed to convince investors of their potential to end the crisis.
Amid official schemes, one called Resolution was recently launched as a regulatory mechanism which restructures and, where necessary, winds down a lending institution by doling out losses to both equity and debt holders.
This follows on from the 5 billion euros invested by bank personnel, insurers and investors in a rescue fund named Atlante, set-up in April to buy banks' bad debts and invest in their equity in an attempt to put them on a steady enough footing to return to their job of lending to businesses and supporting economic growth.
Meanwhile, on Monday morning Italy's banking regulator, Consob, approved the debt-to-equity conversion proposed by the large and beleaguered Banca Monte dei Paschi di Siena, as part of a hoped-for total 5 billion euro capital increase.
Yet fears grow that negative news surrounding the referendum could hit support for this capital scheme, as well as other planned capital raises, such as Unicredit's multibillion-euro hoped-for increase, further details of which are set to be announced on December 13.
The negativity surrounding the Italian banks was echoed in a research report published Monday by Deutsche Bank, in which the investment bank said it expected no "immediate proactive systemic solution" for the sector even in the case of constitutional reform winning the day.
However, the report's authors acknowledge their view may be overly pessimistic and that there is the potential for a better outcome.
"A systemic solution to the banking sector could be a chance of turning the current growth-banks-politics vicious circle into a virtuous one and revitalize the reform process," the report said.
"In the case a proactive systemic solution is implemented we would significantly revise upwards our GDP forecasts."