OREANDA-NEWS. The impact of Italy's reforms agenda will take time to materialise and for the medium term, pressures abound across key sectors, particularly banking and SMEs, says Fitch Ratings.

Italy's banking sector is burdened by weak asset quality and considerable fragmentation. Data provided by Datastream and Bank of Italy shows that the rising stockpile of impaired assets peaked in January 2016 but in our opinion Italian banks will need to set aside additional loan loss provisions going forward and this may force some to raise additional capital.

Italy has left it late to identify its NPL problem. Ireland and Spain, for example, were able to recapitalise their banks before mandatory bail-in under the EU's Bank Recovery and Resolution Directive was in force. The schemes now being launched in Italy face more challenges and there is a risk that they may not be able to deal with the asset quality problems effectively. In addition, the sovereign is among the most indebted in the world and the government's lack of balance-sheet headroom leaves little scope for significant growth-enhancing fiscal stimulus.

A weak SME sector lies at the heart of the banking sector's asset-quality problems and SMEs dominate the banks' NPL portfolios. New insolvency laws may encourage banks to process their NPLs more quickly but a lot depends on how easily they are able to take control of collateral - which is often tied up in a business or is the primary residence of the family which owns the business - and whether collateral values hold up.

The outcome of the October 2016 constitutional referendum will be key to determining whether reform momentum continues or stalls. To date, labour, electoral, corporate insolvency and educational reforms have been passed, but it is still too early to determine whether these reforms will significantly raise long-term GDP growth.