Few people outside of the financial media are talking about it, but Italy's banks are virtually bankrupt.

Italy is once again in the spotlight. As its banking system undergoes a slow-motion implosion – the country’s banks are weighed down by €360 billion of bad loans, of which €200bn are deemed insolvent – all eyes are now on the Renzi government.

The inescapable point of Italy's banking crisis is that it can't be contained, only solved. And it can't be solved without fixing Italy's moribund economy.

Much has been said in recent months about the mismanagement of Italian banks: the rampant corruption, fraud, and abuse; the widespread practice of distributing loans to friends and family; the unsavoury ties to politics, etc. There is some truth to this. But it is not the chief cause of the Italian banking crisis, as many commentators have asserted or implied. The crisis is ‘the consequence of the longest and deepest recession in Italy’s history’, as the governor of the Italian central bank, Ignazio Visco, recently stated. As financial journalist Matthew Lynn writes: ‘Italy doesn’t have a banking crisis; it has a euro crisis’.
In macroeconomic terms, Italy has been the hardest hit country in the eurozone after Greece. Its GDP has shrunk by a massive 10 per cent since 2007, regressing to levels of over a decade ago. As a result, around 20 per cent of Italy’s industrial capacity has now been destroyed.

Banca Monte dei Paschi, founded in 1472, is the oldest lender in the world. BMPS is Italy’s third-largest bank by assets.
It's shares are down 75% on the year, and are now nearly worthless.

Under a stress scenario its Common Equity Tier 1 (CET1) slumps to negative 2.44%. In other words, the world’s oldest bank is not just insolvent in an adverse scenario; it’s insolvent right now.

BMPS was already bailed out twice.
UniCredit, Italy’s largest bank, is in nearly as bad of situation.
The ironic thing is that the destruction of Italy's economy was intentional.

Italy’s endemic structural problems – its supposedly hyper-rigid labour market, its bloated bureaucracy, its excessive tax rates, etc. – are notorious but it’s undeniable that the post-2011 economic collapse is a direct result of the austerity policies implemented by the Monti government in 2011-13 and since, including by the current Renzi government. After all, Monti himself admitted in an interview to CNN that his policies’ aim was ‘to destroy domestic demand through fiscal consolidation’, with the aim of rebalancing Italy’s current account deficit.
On its own terms, the policy worked: private consumption collapsed, imports fell and Italy’s current account deficit was turned into a minor surplus. But in an economy heavily dependent on domestic demand – Italy’s exports account for less than 30 per cent of total output – this was bound to take a very heavy toll. And it did. Just between 2009 and 2013, more than 1.7 million small and medium enterprises (SMEs) were forced to close. This, in turn, inevitably sent shockwaves throughout the banking system, which was and is heavily exposed to SMEs.

The IMF has recently estimated that Italy’s economy will not return to its pre-crisis size until 2025.
Loans aren't performing (i.e. being paid) because no one is making any money.

Italy’s banks are neck-deep in nonperforming loans. Official data puts the total amount of nonperforming loans, or NPLs, at around 200 billion euros ($220.5 billion), or around 8% of total loans (see table above). But some analysts argue that another €160 billion worth of loans could soon be pushed into NPL status, according to Wells Fargo, which would put the NPL ratio at an “eye-popping” 15% of their loan portfolios.

The critical problem isn't just the danger to Italy needing to exit the Eurozone in order to save itself. The biggest danger is that the rest of the Eurozone banks are barely hanging on themselves, and can't withstand an Italian economic shock.

The market capitalization of Deutsche and Credit Suisse has shrunk so much that they just suffered the ignominy of being ejected from the Euro Stoxx 50, a stock index designed by Deutsche Börse Group that comprises Europe’s 50 largest and most liquid stocks.