The International Monetary Fund (IMF) cautioned a recent bail-in of retail investors in Italy, which since the Brexit fallout has risen to the top of minds in Europe as a potential issue for the continent. The situation has become troublesome given the influx of non-performing loans (NPLs) and poor shape of balance sheets in the country, which underscored the need for financial industry reforms.

The IMF has championed reform issues on the continent before – just last year the Washington-based fund found itself at the center of a debate between Greece and EU lenders, which ultimately resulted in a default and further stained relations. According to a recent IMF report, NPLs have shown signs of stabilizing however, constituting upwards of 18% of total loans in Italy.

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Still, the ongoing talks between the European Commission and Italy’s Banca Monte dei Paschi di Siena SpA, among others, has reached an impasse over potential losses, namely as to whether creditors should incur losses if taxpayer funds are used. In particular, a set of rules took effect earlier this year that required bondholders and shareholders to absorb losses in failing lenders in the event of a rescue – this mechanism was known as a bail-in.

Given the tenuous state of its finances, Italy has favored a precautionary recapitalization under the current EU’s bank-resolution rules. In doing so, this would allow governments to fortify lenders when capital gaps emerge in stress tests, per a recent Bloomberg report.

Lean Growth Projected

Presently, the Italian financial system is encumbered by approximately $398 billion in troubled loans, as stipulated by the European Central Bank (ECB). The ECB has ramped up pressure on Italian lenders however, specifically in regard to its balance sheets that have hurt lending.

For its part, the IMF has pushed measures such as acute debt restructuring mechanisms, strengthened supervision, as well as a systematic assessment of asset quality for banks. Even if these measures were taken, the IMF has warned that Italy’s economic recovery “is likely to be prolonged and subject to risks,” hampered by a projected growth of only 1.1% in 2016 and 1.3% in 2017.