Italian bank shares sink further on government debt jitters
* Italy risk premium vs Germany at fresh 2-yr high of 244 bps
* Banking index down 3.6% after 8.5% drop on Friday
* Monte dei Paschi faces more costly capital raising
* Banks have cut BTP holdings, remain exposed to loan losses
By Valentina Za
MILAN, June 13 (Reuters) - Shares in Italian banks plunged further on Monday as investors fretted about Rome's debt costs surging higher ahead of the European Central Bank's first rate hike in over a decade.
Italian banking shares are correlated to the risk premiums on the country's debt, of which lenders remain large holders despite efforts in recent years to diversify portfolios and reduce the impact of price swings.
Banks are also exposed to Italy's economy, where higher borrowing costs will further squeeze companies and consumers already grappling with record-high energy prices.
Italy's benchmark 10-year yield DE10IT10=RR rose to 4% on Monday, its highest since January 2014, pushing the premium offered over safer German paper to a new two-year high.
Markets are testing the ECB's resolve to support southern 'peripheral' countries amid expectations it will hike rates in July and end asset purchases that brought into its coffers a fifth of all Italian government bonds.
The policy reversal has sparked fears of "fragmentation", where financing conditions diverge across euro zone member states.
The ECB has pledged to fight unwarranted fragmentation but failed to unveil any tools to do so at a meeting last week.
Sources have told Reuters a large majority of ECB policymakers sees no need for now to announce new purchases to rein in spreads as borrowing costs remain low.
At 1200 GMT, Italy's banking index .FTITLMS3010 was down 3.6%, having lost a quarter in value since the start of the year. Shares in Italy's biggest bank Intesa Sanpaolo ISP.MI were down 4.4%, and UniCredit's CRDI.MI were down 2.5%.
BPER Banca EMII.MI , which on Friday presented a new business plan bracing for higher bad loans and cost inflation, lost 2%. BPER had closed down 13% on Friday, when Italy's banking index fell 8.5%.
Shares in Banca Monte dei Paschi di Siena BMPS.MI fell 3.3% ahead of a new strategy next week that will require the state owned bank to raise at least 2.5 billion euros in capital.
Higher sovereign debt rates inflate costs for banks raising cash on debt and equity markets. Their loan books are also at risk if borrowers struggle with rising interest payments.
Italian banks' profits have been hammered for years by provisions they had to book to offload bad debts.
Banks are also directly exposed to falling bond prices through their sovereign holdings, though since the euro zone crisis of 2011-2012 they have taken action to limit the impact on capital.
JPMorgan analysts calculate that holdings of domestic 'BTP' bonds at Italy's top five banks amounted to 1.5 times their core capital, down from 2.6 times five years ago.
Moreover, the percentage of bonds held a fair value - which requires banks to 'mark to market' the assets, eroding capital reserves - is less than 42% of the total, from 85% in 2017.
To insulate themselves from price swings banks can hold the bonds to maturity.
"Both Spanish and Italian banks improved significantly ... their overall capital, asset quality and liquidity position, and profitability has high gearing to rising rates," Citi analysts said in a note.
"Any potential announcement from ECB to mitigate/control government bond yields in periphery would be positive for banks' shares, but might not materialize very quickly," they added.
Italy banks Link
Reporting by Valentina Za;
Editing by Mark Potter
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