Italy's highest bond yields since the birth of the euro are reverberating through the financial system of Europe's biggest debt issuer, driving lenders to seek record amounts of central bank financing.
Italian banks borrowed 111.3 billion euros ($152 billion) from the European Central Bank at the end of October, up from 104.7 billion euros in September and 41.3 billion euros in June, Bank of Italy data shows.
The five biggest lenders — UniCredit SpA, Intesa Sanpaolo, Banca Monte dei Paschi di Siena SpA, Banco Popolare SC and UBI Banca ScpA — accounted for 61% of the country's use of ECB resources in September, almost double the share in January.
After punishing Greece, Ireland and Portugal for their rising debt loads, the bond market is now targeting Italy, pushing bond yields in the euro zone's third-largest economy above 7% as the nation's lenders prepare to refinance $120 billion of debt maturing next year.
Italy's $2 trillion in liabilities exceed those three countries combined, plus Spain.
"The banks are deleveraging on a tightrope," Alberto Gallo, a credit strategist at Royal Bank of Scotland Group PLC in London, said in an interview.
The slump in Italy's bonds, which sent the 10-year yield soaring to as high as 7.48% Nov. 9, is reducing the value of fixed-income securities held by banks, eroding their value as collateral for loans, Gallo said.
The extra yield investors demand to hold Italian 10-year debt rather than German bunds rose to a euro-era record 5.53 percentage points on Nov. 9 before falling back to 4.56 percentage points.
Italy's top 32 banking firms have about 88 billion euros ($120 billion), or 3.2% of their liabilities, maturing in 2012, according to the Bank of Italy.
Next year's maturities coincide with about 307 billion euros ($419 billion) of the government's debt coming due, the most ever, according to data compiled by Bloomberg.
Italian lenders are seeking to broaden their sources of funding. Corrado Passera, the chief executive of Intesa Sanpaolo SpA, said on Nov. 8 the bank can do without wholesale funding for all of next year, and rely on deposits and bonds it sells to individual customers.
Retail funding made up 54.1% of the Italian banking system's total as of June, compared with 48.8% in the rest of the euro zone, according to the Bank of Italy.
The cost of that money increased 0.4 percentage point, or 40 basis points, to 1.7% in the nine months ended Sept. 30 as the funding mix shifted to products such as repurchase agreements and fixed-term deposits that pay clients more, central bank data shows.
Italian banks' share of ECB lending rose to about 19% of the total in October, according to the Bank of Italy.
That's up from 15%, or 91 billion euros ($124 billion), in September, the data shows.
"The Italian banks are trapped," said Roger Doig, a London analyst at Schroders PLC, which manages about $58 billion in fixed-income assets. "They are where they are and that's with the Italian sovereign. The austerity required if the sovereign wants to remain in the euro zone means there's going to be a recession, which will mean losses for the banks."
"The market is pricing in an Italy event and assuming that Italy fails," said Patrick Lemmens, a senior money manager who helps oversee about $13 billion, including Intesa Sanpaolo shares, at Robeco Groep in Rotterdam.
"Italian banks have been crushed in the carnage in the government bond market," said Suki Mann, a strategist at Societe Generale SA in London. "It could get worse."