MercoPress. South Atlantic News Agency

Italy's referendum could knock out Rienzi and unleash a financial volcano

There are real concerns that a defeat for Mr Renzi's proposals could unleash a chain of events that would set back the country's economy once again.

The focus of the news from Italy this weekend will be political: there's a referendum on constitutional reform and the Prime Minister, Matteo Renzi, has said he will resign if the proposals are rejected. This could be followed by new elections which could in turn benefit the Five Star Movement, an anti-Euro group led by the former comedian Beppe Grillo.

 The Movement is one of many protest parties that have surged in popularity across Europe in recent years. But behind the politics in Italy there's a background of persistent economic weakness and a more immediate problem in the banking industry.

There are real concerns that a defeat for Mr Renzi's proposals could unleash a chain of events that would set back the country's economy once again. In effect Italy's banks are currently one of the main trouble spots for the euro zone. They are struggling with a burden of bad debt, loans that are unlikely ever to be repaid fully.

The banks are a potential flashpoint in an economy that has for some time been seen as posing wider risks to the EU's currency area.

However, it is the size of the Italian economy and government debt that make the country a smouldering financial volcano. The risks are aggravated by the political situation.

Italy is the third-largest economy in the Euro zone and the government debt burden, depending on which figures you look at is certainly one of the largest in the Euro zone. In fact, on one measure its debt burden is the largest.

One of the roots of the problem is Italy's two decades of dismal economic performance. Measured by total economic activity (gross domestic product, or GDP), the economy remains about 8% smaller than it was at the onset of the international financial crisis.

It is roughly the same size as it was at the turn of the century. That has made it harder to generate the tax revenue needed to keep the government's debt burden down. It has also increased the chances of businesses getting into difficulty and being unable to maintain their loan payments.

The result: Italian banks are weighed down with a massive problem of bad debts, or non-performing loans (NPLs), worth €360bn, equivalent to about a fifth of the size of country's economy.

There are real concerns that a defeat for Mr Renzi's proposals could unleash a chain of events that would set back the country's economy once again. In effect Italy's banks are currently one of the main trouble spots for the euro zone. They are struggling with a burden of bad debt, loans that are unlikely ever to be repaid fully.