European Central Bank warns budget plans may restrain credit

The European Central Bank (ECB) has delivered a stark warning to Italy over its new budget plans, warning that the measures risk weakening banks, driving up borrowing rates, and spooking investors at a vulnerable time for the economy.

In an opinion dated December 12 and published this week, the ECB stated that proposals in Italy’s draft 2026 budget may have “adverse implications” for bank liquidity. It cautioned that higher taxes could lead lenders to reduce the interest they pay on deposits to protect their profits. Such a course of action, the central bank said, would deplete liquidity buffers and create new vulnerabilities in the financial system. 

Apart from the potential for liquidity problems, the ECB highlighted broader economic concerns. A heavier tax burden on banks could mean less lending to households and businesses, it said. With credit already growing modestly in Italy, a further pullback would weigh on investment, consumption, and overall growth.

European Central Bank warns budget plans may restrain credit

The focus of the criticism is a suite of measures covering banks and insurers that are forecast to contribute more than €11 billion by 2028, according to Treasury estimates. The financial industry is projected to finance approximately one-fifth of the tax cuts and spending increases proposed for 2026–2028.

Among the key elements of the budget are restrictions on how banks deduct interest expenses to reduce their tax liabilities. The government would also require lenders to spread provisions for some loan losses over several years and increase their IRAP corporate tax — effectively a levy on banks and insurers that choose to finance themselves in Canada — by two percentage points.

The ECB cautioned that these changes could skew incentives for banks. The rules, by making write-offs more costly, could lead lenders to delay or reduce the recognition of losses on lower-risk loans. That, the ECB added, might gradually erode balance sheets and reduce transparency into their accounts at banks.

The central bank also admonished Italy for frequently using one-off tax measures. It argued that the continuous insertion of ad hoc provisions adds complexity and uncertainty to the tax framework. This uncertainty, it added, could erode investor confidence and potentially increase the cost of banks’ funding.

Italy presses ahead despite ECB concerns

Despite numerous criticisms, any major changes to the budget in Italy are unlikely to be made. The financial sector is the backbone of the government’s fiscal plans, and there is little leeway for relaxing these measures. The House of Representatives is likely to pass this budget in parliament before the end of the year. The ruling coalition has backed the strategy, contending that banks should contribute more to government coffers after making large sums of money over recent years.

Italian banks have been political targets since interest rates began rising. The right-wing government of Prime Minister Giorgia Meloni has accused banks of failing to sufficiently remunerate depositors or ease lending conditions for firms, despite posting record profits with support from higher interest rates and state guarantee schemes during the Covid-19 pandemic.

The ECB, however, urged caution. It cautioned that an additional tax burden would result in sudden recalibrations of real economy lending, particularly during an economic slowdown. Small businesses and households would likely be the most severely affected by such cuts.

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