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Italy’s referendum could spark another European banking crisis: Economist

This Sunday's referendum in Italy could kick off another banking crisis in Europe, according to one economist.

"In my view the biggest risk is actually for the banking sector, even more so than political risk, and there will be some political instability," Megan Greene, ‎chief economist at Manulife Asset Management, told CNBC on Tuesday.

Italian voters have been asked to approve reforms to the country's constitution, but most voters see the upcoming referendum as a vote on the prime minister and the current government. Prime Minister Matteo Renzi has previously stated that he would resign if the reforms are rejected. Expectations are that voters will say "no" to the reforms and bring political and financial instability back to the third largest euro zone economy.

"If you have a crisis in the Italian banking sector kicking off again, not only that could spread across Europe but also the solution that Renzi may come up with to just break the rules and bailout the banks, in which case he would be massively undermining (the) banking union, which is actually the only area where they made progress in Europe since the beginning of the crisis," Greene added.

Patrizia Cortellessa | Pacific Press | LightRocket | Getty Images

A banking crisis in Italy is seen as being possible if investors decided to stop contributing to a solution that addresses some of Italy's weakest banks. Asset managers, insurers and banks agreed earlier this year to set up a 5 billion euro fund ($5.30 billion) to bail out weaker lenders, and thus, calming concerns over the stability of the Italian banking sector - burdened by a high level of non-performing loans.

According to a report by the Financial Times on Monday, citing officials and senior bankers, up to eight Italian banks could be in trouble if voters choose "no" in the referendum.

If polls prove to be correct and Renzi loses the referendum, analysts argue that he would be forced to form a new government, but an early election would be unlikely.

"Investors may not be interested in participating anymore if you have all this political instability in Italy off the back of this referendum," Greene told CNBC.

"That government won't be able to do anything but electoral reform, so Italy won't get the structural reforms that it needs," Greene added.

Meanwhile, Italian officials have downplayed the impact the referendum result might have on banks and on Europe. Paolo Gentiloni, the Italian foreign affairs minister, told CNBC Monday that market concerns of a potential default are not justified.

Gentiloni told CNBC that such fears were reasonable in 2011 but the country had improved since then. He added that there are no risks of contagion to Europe. "In any case we will have a weaker and more unstable country, but not a threat for the European economy," he said.

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