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the ECB has voiced concerns that Italy’s budget initiatives could weaken the banking sector and slow down lending activity. Increased fiscal burden on banks could lead to higher borrowing costs and restrict lending to both individuals and businesses.

Italy is expected to pass the budget despite worries about possible damage to economic growth and investor sentiment.

The European Central Bank (ECB) issued a strong warning to Italy over its new budget proposals, signaling that the moves could weaken banks, raise interest rates and scare away investors at a difficult time for the economy.

In a Dec. 12 opinion released this week, the ECB said provisions in Italy’s draft 2026 budget could have “negative repercussions” for bank liquidity. The regulator cautioned that the tax hike could prompt credit institutions to cut deposit rates to maintain their profitability. The central bank believes that such actions would deplete liquidity reserves and trigger new vulnerabilities in the financial structure.

In addition to potential liquidity problems, the ECB has raised broader macroeconomic concerns. According to the ECB, the tightening of taxation of banks may result in a reduction of credit offers for households and businesses. With credit growth in Italy already subdued, a further slowdown would have a negative impact on investment activity, consumer demand and overall growth dynamics.

The focus of criticism is a package of measures affecting banks and insurance companies, which, according to calculations of the Ministry of Finance, should bring more than 11 billion euros by 2028. Financial institutions are expected to cover about a fifth of the deficit generated by tax cuts and spending increases between 2026 and 2028.

key elements of the budget include restrictions on interest expense deductions by banks to reduce their tax liabilities. The government also intends to require lenders to spread the deductions for potential losses on certain loans over several years and to increase by two percentage points the IRAP tax on corporations – essentially a tax on banks and insurers using Canadian funding mechanisms.

The ECB warned that these innovations could distort incentives for banks. The regulatory changes, by making it more costly to write off losses, could encourage lenders to defer or reduce the recognition of losses on less risky loans. The ECB believes that this could lead to a gradual deterioration of balance sheets and reduce the transparency of banks’ reporting.

The central bank also rebuked Italy for its frequent use of ad hoc fiscal instruments. In its opinion, the constant introduction of special regimes complicates the tax system and makes it unpredictable. Such uncertainty can undermine investor confidence and potentially increase the cost of raising bank capital.

Despite all the comments, significant amendments to the Italian budget are unlikely to be expected. The financial sector is the cornerstone of the government’s fiscal intentions, and it has little leverage to soften these measures. The Chamber of Deputies is likely to approve this budget before the end of the year. The ruling coalition has defended the policy, arguing that banks are obliged to contribute more to the state coffers after generating significant revenues in recent years.

Italian banks have been the target of political pressure since interest rates began to rise. The center-right government of Prime Minister Giorgia Meloni accuses banks of not adequately rewarding depositors or easing credit conditions for businesses, despite record profits from rate hikes and government guarantees during the COVID-19 pandemic.

the ECB, however, insists on prudence. It warned that additional tax burdens could trigger a sharp shift in lending to the real economy, especially during a slowdown. Small businesses and private households are likely to be most vulnerable to such a reduction.