Billions in bad debts in italian banking sector lead to fears over fresh european economic crisis

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EUROPE could be plunged into a new economic crisis later this week amid fears about the health of the Italian banking system.

On Friday, the European Banking Authority will release the results of comprehensive stress tests from 51 banks across Europe covering 70 per cent of the sector.

The tests will focus on the use of capital guidance to cover potential shortfalls and many fear disastrous results for Italian lenders including the worlds oldest bank, Banca Monte Paschi which is also the countrys third biggest lender.

The results have been the subject of discussion at a meeting of G20 Finance bosses in China over the weekend. Investors and political leaders fear that nearly $530 billion worth of bad debts held by Italian banks could trigger a new financial crisis in the eurozone already struggling with a Greek bailout and the unknown implications of the second biggest economy leaving after Brexit.

Italian banks are reported to have around 360 billion euros (A$528 billion) in non-performing loans. That restricts economic growth as it reduces the amount banks are able to lend and can be disastrous if companies find their debts called in or access to funds cut off.

Last week, European Central Bank boss Mario Draghi said European banks were slightly better than they were before but still needed to address the problem of weak profitability.

He said non-performing loans posed a significant problem for the future ability and the capacity the banks have of lending.

The warning comes amid new rules in Europe designed to protect taxpayers from costly bailouts which means investors wear the burden of bailouts first.

Earlier this month the IMF warned Italy will not return to pre-crisis growth levels until the mid 2020s. At present, the country has the second highest debt level in Europe after Greece.

Despite fears, Italian finance minister Pier Carlo Padoan sought to defuse the situation at the G20 meeting in China saying the country does not have a problem with its economy.

All the countries should relax: there is no Italian banking problem, he told AFP.

There is an economy which has been in recession for three years, there is accumulated non-performing loans, which have been dealt with.

He said the numbers that were floating around were vastly exaggerated and a few cases would be adjusted.

He also said there are no tensions between Italy and the European Commission on the issue.

We are not on a bailout regimen, we are in a bail-in regimen, and all the instruments that are considered are within those rules, he said. There is no need to bail out anybody.

EU economy chief Pierre Moscovici said any solution to Italys banking woes had to fit with the terms of the common market. The messages from the Italian representatives had been quite affirmative and reassuring, he added.

US officials said that Treasury Secretary Jacob Lew and Mr Padoan had discussed recent developments in the European banking sector in China.

In a statement, the US Treasury said that Mr Lew had noted that while Europes banking system is stronger as a whole due to reforms put in place in recent years, more work remains.

Banks should continue to clean up their balance sheets and address legacy asset quality issues, it said.

BBC business editor Robert Peston analyses the state of the monetary union in Europe.