Italian Banking Association - Annual Meeting
Speech by Ignazio Visco
Governor of the Bank of Italy
ABI
Rome 8 July 2022
The economic situation and monetary policy
The global economy is experiencing a period of great uncertainty. Russia's attack on Ukraine is
having serious repercussions on manufacturing and on trade and is driving up inflation, which in
Europe in particular reflects the continuing and exceptional rises in energy commodity prices, and
to a lesser extent, of food prices. The outlook is also being affected by the ongoing difficulties in
international supply chains for intermediate goods, recently made worse by the restrictions
introduced in China to counter the spread of COVID-19 cases. There is the risk of a sharp
slowdown in some advanced economies, above all in the United States, where the containment of
inflation, also caused by a considerable increase in aggregate demand and in labour costs, requires
a particularly vigorous monetary policy response. Global economic activity in any case remains
exposed to possible resurgences of the pandemic.
In the Eurosystem's projections of early June, euro-area growth in 2022 was lowered to 2.8 per
cent from the 4.2 per cent forecast in December. This increase had already largely been achieved
thanks to the strong recovery in 2021, and implies an expansion lower than 1 per cent over the
course of this year. GDP is currently being driven by the full re-opening of business activities,
especially in services, which are also benefiting from the impetus provided by the strong
resumption of tourism; the negative effects of the energy shock on household spending are
mitigated by the ample availability of savings, by fiscal measures and by the gradual recovery of
the labour market.
In June, consumer prices increased by 8.6 per cent in the euro area compared with the same
month last year. Their growth continues to be fuelled by the rise in oil prices and above all gas
prices that, following further cuts in supplies from Russia, have risen sharply from €80 to more
than €180 per megawatt hour since mid-June; they stood at around €30 one year ago, when flows
from Russia had already declined, and at just over €10 before the pandemic. Net of the most
volatile components, inflation has reached 3.7 per cent, since it, too, is influenced by the
transmission of higher energy costs to the final prices of other goods and services.
Inflation is likely to remain very high on average this year; it is expected to fall markedly in 2023
and then return to around 2 per cent in 2024. The latest forecasts from the leading international
institutions and private analysts, as well as those inferred from the prices of financial assets
indexed to consumer prices, confirm that long-term expectations remain broadly in line with the
European Central Bank's (ECB) definition of monetary stability.
Nevertheless, in the current environment of high inflation, a gradual normalization of monetary
policy, which had been calibrated to contain deflationary and recessionary pressures during the
most serious phase of the pandemic crisis, is needed. The risk that, in the long run, exceptionally
high price increases will eventually impact expectations or trigger a price-wage spiral should be
countered, although wage growth, despite having strengthened, remains moderate for the time
being. The ECB Governing Council therefore decided to end its net asset purchases from the end of
last week. In addition, it announced its intention to raise the key interest rates by 25 basis points
at the meeting on 21 July; an even larger increase could be appropriate in September if the
medium-term inflation outlook does not improve. The pace of the subsequent gradual but
sustained process of interest rate increases will depend on the new economic and financial data
and on how they will affect the prospects for prices.
Partly because of the unjustified perception of a particularly aggressive monetary policy stance,
the first half of June was characterized by a sharp upward revision of expectations for key interest
rate rises and by an abrupt increase in long-term interest rates, which play a key role in the
economic activity of firms and households. Tensions have overwhelmed the markets for public and
private bonds and spread to the equity market. The considerable widening of yield spreads
between the government bonds of euro-area countries perceived as being more vulnerable and
German bonds points to growing risks of market fragmentation along national borders.
Given these trends, at an extraordinary meeting on 15 June, the Governing Council decided that
reinvestments under the pandemic emergency purchase programme (PEPP) would be conducted
flexibly, and announced the acceleration of work to create a new tool designed to counter
fragmentation. These measures aim to ensure as homogeneous a transmission of monetary policy
as possible across euro-area countries, ensuring the smooth normalization needed to bring
inflation back into line with the price stability objective.
The announcement of the Council's decisions contributed to a sudden and significant reduction in
public bond spreads; the peak of around 250 basis points reached in the spread between Italian
and German ten-year government bond yields shortly before mid-June is inconsistent with the
fundamentals of Italy's economy.
The context is still one of high volatility: it therefore remains crucial to prevent financial conditions
from becoming excessively tight, as this would have serious repercussions for financial stability,
for economic activity and, ultimately, for medium-term price growth. It is essential that monetary
policy action be combined with a clear determination on the part of the fiscal authorities to keep
the public finances on an even keel.
Geopolitical tensions are having a marked impact on the Italian economy too, which, together
with that of Germany, is one of those most dependent on commodity imports from Russia. In
January, we expected output growth to be above 3 per cent on average in the years 2022-23; in
the June baseline scenario, in which war-related tensions are assumed to persist throughout 2022
but with no suspension of gas supplies from Russia, growth has been revised downwards, by 2
percentage points for the two years as a whole, close to the values of the euro area. Inflation,
which in June exceeded 8 per cent in Italy as well (four fifths of which due to the direct and
indirect effects of energy and food prices), is holding back growth by significantly compressing
incomes in real terms, only partly offset by fiscal measures.
In an adverse scenario featuring a halt in supplies from the third quarter of this year, only partially
replaced by other sources, GDP would contract on average in the years 2022-23, and return to
growth in 2024. The direct effects of an interruption on the more energy-intensive sectors, further
increases in commodity prices, a more marked slowdown in foreign trade, a deterioration in
confidence and an increase in uncertainty would all contribute to the worsening of the
macroeconomic situation.
Substantial support to economic activity is in any case coming from the measures outlined in the
National Recovery and Resilience Plan (NRRP), which is being implemented according to the set
deadlines. In the coming weeks, the European Commission will assess whether the 45 milestones
and targets agreed for the first half of 2022 have effectively been achieved, which is linked to the
disbursement of a new €21 billion tranche of funding. For this period, the Plan envisaged progress
on major reforms, such as the code of public contracts and public employment, as well as the
launch of several investment programmes. The difficulties encountered in awarding a number of
tenders have not compromised the ability to stick to the timeframe and achieve the expected
results.
In the coming months, the commitment to implementing complex reforms, such as those for
competition and the justice system, will need to be flanked by a gradual acceleration in
investment programmes. If local authorities have difficulty in planning and implementing
measures, it will be important to make timely use of the technical support instruments already
envisaged. Rising energy prices and problems in the supply of raw materials pose further
challenges. These difficulties, which are being countered by specific compensation measures
already partly introduced, do not require a radical review of the Plan, nor do they imply a
slowdown in its implementation. On the contrary, they make it even more urgent to step up the
measures relating to the green transition, also by using the additional resources made available by
the REPowerEU programme.
Banks
Italy's banks are responding to this difficult cyclical situation from a position of substantial
equilibrium. At the end of March, the CET1 ratio was equal to 14.6 per cent; despite the
resumption of dividend payments, it remains higher than it was before the outbreak of the
pandemic. In the first quarter, the annualized return on equity came to 6.4 per cent, less than in
the corresponding period of last year, but slightly higher than the level recorded for 2021 as a
whole. The new non-performing loan (NPL) rate, computed on an annualized basis and adjusted
for seasonal effects, fell by 0.2 per cent in the first three months of this year, to 1 per cent; in the
absence of significant disposals, the stock of these loans net of loan loss provisions and, again,
relative to total loans, remained broadly unchanged. By contrast, losses on the securities portfolio
associated with market volatility are on the rise.
Credit supply conditions have become less favourable in recent months, although lending to the
non-financial private sector continues to grow, albeit at a moderate pace for firms. The liquidity
position of the latter nevertheless remains good. Possible liquidity needs associated with the
economic fallout of the war could also be met through State-guaranteed loans; in fact, the new
credit support measures taken by the Government after the outbreak of the conflict in Ukraine
extended the application window for these loans until the end of this year, in line with the EU's
State Aid Temporary Framework.
The rise in interest rates is not expected to halt credit growth. The impact on banks' profitability
should be positive overall, owing to the increase in net interest income, whose performance will
depend on the maturity structure of individual banks' assets and liabilities, with quite significant
differences among intermediaries.
Over the medium term, the amount of additional loan loss provisions corresponding to the rise in
NPLs should be more than offset by the positive impact of higher interest rates on net interest
income.
A fall in Italian government bond prices has a direct impact on regulatory capital, even when the
corresponding losses are not recorded in the income statement. If we consider the stock of
onbalance-sheet securities recorded at market value at the end of May, it can be estimated that an
increase of 100 basis points along the entire yield curve would lead to a reduction of around 20
basis points in the CET1 ratio.
The withdrawal of the support measures put in place to address the pandemic crisis is ongoing,
with no significant repercussions on credit quality. Although it is increasing, the share of loans
classified as NPLs that have benefited from moratoriums remains relatively low, while that of
loans for which banks have recorded a significant increase in credit risk since origination (classified
as 'Stage 2' according to international accounting standards) is diminishing. The data on delays in
payments on performing loans do not show signs of a significant deterioration for now.
The quality of State-guaranteed loans to the firms hit hardest by the pandemic, which can be
requested until the end of June, also continues to be good. The new NPL rate is still low, although
for loans granted in the early stages of the pandemic, the grace period during which firms were
permitted to make just interest payments is now ending. The preliminary data also suggest that
only a few borrowers have availed of the recently introduced possibility of requesting an
extension.
Direct exposures to the countries affected by the war have remained broadly stable; the
intermediaries with which these claims are concentrated have reviewed their accounting
classifications and increased their loan loss provisions accordingly.
The ECB and Banca d'Italia have urged banks to carry out in-depth analyses of the solvency
outlook for the firms hardest hit by the consequences of the conflict, in particular those most
impacted by the extraordinary increase in energy costs.
Recognizing the heightened risks involved, many banks have started to increase loan loss
provisions on these exposures as well.
As I recalled earlier, there is a real risk of a contraction in economic activity.
Policies for the distribution of profits and for provisions must take due account of the heightened
uncertainty and the considerable downside risks to macroeconomic developments.
Supervision, crisis management and banking union
Over the past few years, Banca d'Italia's supervisory action on the less significant banks has aimed
at identifying the most fragile intermediaries ahead of time and requesting increasingly intensive
remedial actions to prevent their economic and financial conditions from deteriorating. This has
led to more robust small and medium-sized banks overall, as witnessed by the general
improvement in capitalization levels and the reduction of risks, which have also benefited
indirectly from support measures for access to credit introduced by the Government to address
the effects of the pandemic crisis.
At the end of 2020, we had conducted a survey on the sustainability of the business models of a
large sample of less significant banks, followed in 2021 by actions tailored to the conditions of the
individual banks involved. While the situation is balanced for most banks, elements of fragility
remain in some cases, especially in relation to banks' ability to generate income flows suited to
managing risks, funding innovative investments and remunerating capital. For some less proactive
banks with deficiencies in management, the weaknesses identified may jeopardize the
sustainability of their business model to the point that they may become non-viable; in these
instances, they have then been called on to make a rapid assessment of options to overcome the
crisis, including through possible mergers with other banks.
In recent years, a special public fund has been established to support the orderly winding-up of
banks with total assets of below €5 billion, which can only be availed of until next November. In
view of the approaching deadline, new instruments need to be found to finance the restructuring
of the most fragile institutions, when possible preventing crises and the resulting negative
externalities for the whole sector. While it is still desirable for operators to enter the market that
are specialized in bank restructuring and equipped with the capital resources and professional
skills necessary to support their revitalization, this need could also be met by the banking system
itself setting up a dedicated vehicle funded at market conditions and supported by public entities.
Supervisory activities pay the utmost attention to the adequacy of corporate governance, to the
professional profile of managers, and to the appropriateness of the time that directors spend on
performing their duties. Corporate governance systems that value professional skill sets, are open
to innovation, and are capable not only of facilitating the formulation of strategies consistent with
the new competitive scenario but also of adequately monitoring new risks, are indispensable for
the stability of individual intermediaries and that of the banking system as a whole. On the other
hand, weaknesses in these areas, especially shortcomings in mechanisms for balancing powers
and decision-making processes, have been one of the main causes of banking crises in recent
years.
Corporate governance surveys suggest that there is room for improvement in the levels of
diversification of boards of directors by gender and expertise.
In the less significant banks, women are particularly under-represented in senior management
roles and their numbers must be increased, also in line with Banca d'Italia's most recent provisions
and recommendations. There is, moreover, a clear need to strengthen the capacity to innovate
and to safeguard against the related risks by increasing the presence of IT experts; critical scrutiny
of managerial proposals and efforts to discuss key issues thoroughly also need to be stepped up.
The need to strengthen corporate governance, to formulate and implement appropriate strategic
plans and to pursue greater efficiency and better risk management at group level, while
maintaining strong local ties, underpinned the choice of the legislature to launch the cooperative
credit banks reform of 2016.
Six years later, despite several initial difficulties and an unfavourable cyclical situation, the new
groups have reduced their share of non-performing loans, lowered cost-to-income ratios, and
almost completely closed the profitability gap that was separating them from the banking system
average. At the same time, they have continued to support the local economies where they
operate and increased their market share in terms of financing to households and firms. They have
played a prominent role in putting public support measures in place to counter the effects of the
pandemic crisis. Banca d'Italia remains open to dialogue with the cooperative credit banking
groups in order to identify areas where supervisory practices and regulation can be simplified so
as to take due account of their particular features.
The completion of the banking union, which currently rests on the two pillars of the Single
Supervisory Mechanism and the Single Resolution Mechanism, cannot neglect the establishment
of the third pillar, a single deposit insurance scheme with a full loss-absorbing capacity when it is
completely phased in. However, in the current political, economic and financial environment, it
has become clear that it is not possible at present to find a balance between the different
positions of the Member States.
The Euro Summit statement of 24 June therefore took note of the Eurogroup's decision of 16 June
to focus its work on banking union in the coming months solely on the review of the regulatory
framework for bank crisis management. The current framework still does not provide effective
tools for small and medium-sized banks: these banks are excluded from the application of the
resolution procedure due to failure to pass the 'public interest test' and, in the absence of other
solutions and in the event of a crisis, would be destined for piecemeal liquidation, unsuitable for
ensuring an orderly market exit. The inefficiency of the current situation is compounded by the
limited room for manoeuvre available to deposit guarantee funds, which risk being unable to
provide sufficient support to ensure the transfer of assets and liabilities to a potential buyer,
thereby avoiding corporate dismantling and serious consequences for unprotected creditors, for
customers and for employees.
The Eurogroup has specifically agreed that the main elements of the review should be: a
harmonized rewriting of the concept of public interest in order to extend the application of the
resolution procedure to more banks, including smaller ones; finding more sources for resolution
funding, which is necessary to make the above-mentioned extension feasible, through a greater
involvement of guarantee funds and a 'least cost criterion' test based on common criteria at
European level but managed by national authorities; and the harmonization of specific elements
of Member States' insolvency regimes to make them consistent with the European framework.
The European Commission has been invited to consider the submission of a proposal and the
colegislators called upon to complete the relative work by the beginning of 2024.
As part of this general approach, some important aspects still need to be defined, starting with the
expansion in the number of banks that can access the resolution framework. It will also have to be
made clear how the minimum requirement for own funds and eligible liabilities (MREL) will apply
to small and medium-sized banks, which, as a result of the abovementioned expansion, would be
destined for resolution. Given their limited capacity to place financial instruments on the capital
market, applying a bail-in to these banks, even at the minimum 8 per cent of total liabilities
needed to access the single resolution fund, would ultimately affect depositors as well as senior
creditors.
In our assessment, a reasonable extension of the range of banks that can access the resolution
procedure could be feasible, provided that there is an extension of the intervention capacity of the
deposit protection fund made possible by removing the super-priority, potentially accompanied by
a reduction in the minimum bail-in required to access the resolution fund. By facilitating
compliance with the least cost criterion test, this removal would also improve the ability of the
funds to intervene (alternatives to repaying protected deposits) to support the disposal of assets
and liabilities in national liquidation procedures.
These considerations are confirmed by the results of an impact analysis conducted last year by the
European Banking Authority at the request of the Commission.
The analysis pointed out that, under realistic loss scenarios, a significant number of intermediaries
(including some of the banks for which, in the event of a crisis, a resolution procedure would be
triggered) would currently not be able to undergo a minimum bail-in of 8 per cent of liabilities
without affecting depositors.
Initial estimates made by Banca d'Italia confirm that, if the scope for resolution were extended, it
would be difficult for less significant Italian banks to comply with the obligation to bail in the
minimum required under the current European rules without creating losses for depositors. For
the many smaller banks that would remain outside the scope of resolution, the same estimates
highlight the limits of deposit protection funds in helping to fund disposals of assets and liabilities
in liquidation. Given the difficulty in overcoming the least cost criterion test, the removal of the
super-priority and maintaining the possibility for funds to continue carrying out the alternative
measures, already provided for by European legislation, seem to be the conditions necessary for
preventing the crises of small banks from having to be managed via piecemeal liquidations.
Also in connection with the revision of the crisis management framework, the Commission has
launched a public consultation in recent weeks on a possible reform of the regulatory framework
for State aid for banks in difficulty. The objective - of which the Eurogroup has taken note - is to
assess the extent to which the current rules have helped to preserve financial stability, while
minimizing distortion of competition and the burden on taxpayers. There will also be an
assessment as to whether there is scope for simplifying the rules and improving their interaction
with the crisis management framework. It is desirable for the rules to remain reasonably flexible in
order to safeguard a proper balance between financial stability and protecting competition.
The challenges ahead
The pandemic crisis was the first test bench we were able to use to assess the current
macroprudential framework in a period of stress. The authorities responded in a timely manner
using a number of tools. In some cases, they intervened by fully or partially releasing the
countercyclical capital buffer (CCyB) or by cancelling scheduled increases to it. In other cases, the
systemic risk buffer (SyRB) or the capital buffers for systemically important institutions were
reduced or cancelled.
In countries like ours, where the conditions of the financial cycle in the years preceding the
outbreak of the pandemic were not such as to justify the build-up of capital buffers, there was less
room for manoeuvre.
Therefore, there is now a need to expand the macroprudential space available to the authorities,
with the aim of increasing the amount of capital buffers that can be released in the face of large
and disruptive systemic shocks that could go beyond normal cyclical fluctuations. Moreover,
borrower-based instruments, such as limits on the loan-to-value ratio, should be harmonized,
even if only minimally, based on the recommendations already issued by the European Systemic
Risk Board.
Last March, we sent the results of the public consultation to the European Commission, publishing
them on Banca d'Italia's website as part of the periodic review of macroprudential provisions. It is
important that the design, activation and calibration of these instruments remain the
responsibility of the national authorities, given the heterogeneity of national credit and real estate
markets.
Within its field of competence, the ECB can at the same time foster their consistent use across
countries.
The difficult cyclical situation should not induce banks to reduce their efforts to respond to
structural challenges, in particular those posed by the 'twin' green and digital transitions. Lowering
our guard on these aspects would mean making up for lost time over the next few years, trying to
catch up with the competition, rather than anticipating it and adjusting to the new rules.
I have often pointed out that it is essential to increase investment in new technologies, innovate
products and processes, and upgrade the skills of bank managers and employees in order to
respond to the competitive pressures from other market participants (regulated and
nonregulated) and to increase efficiency. There is still a long way to go, but there are encouraging
signs coming from our surveys.
Last year, a survey of banks showed that the use of artificial intelligence applications, even if still
limited, is growing. These applications make risk estimates for customers more precise and speed
up assessments of creditworthiness, favouring faster loan disbursement. The survey also indicated
that while banks are aware of the need to adopt models that can be easily understood, they are
not as alert to the need to strengthen their corporate governance arrangements against risks
arising from outsourcing their assessment activities. Safeguards should also be strengthened to
ensure that individual rights are adequately protected and that the methodologies used do not
result in discriminatory practices.
The provision of online credit is increasing. At the end of last year, the share of banks offering
loans to households and firms via digital channels was 44 and 25 per cent respectively. The
capacity to lend remotely and the use of digital tools to assess customers' creditworthiness
allowed banks with a higher rate of technological innovation to increase their market share during
the pandemic crisis.
However, the recent acceleration in the use of new technologies has exposed us to greater risks,
as witnessed in some major cyber incidents. With the outbreak of the conflict in Ukraine, risks are
increasing again and so, together with Consob, IVASS and Italy's Financial Intelligence Unit (UIF),
we promptly warned the banks that they needed to raise their guard against potential attacks.
Against this backdrop, we have also urged banks and the main technology service providers to
conduct a risk assessment linked to the use of software from Russia. So far, there has been no
evidence of any successful cyber attacks on the financial market that can be directly related to the
conflict.
Of the 12 incidents reported in 2021, eight were reported in the first six months, of which 5 were
associated with a single attack on an external service provider.
That episode highlights the risks involved when outsourcing is concentrated around a small
number of operators. In 2020, Banca d'Italia intensified its controls in this context, making specific
and repeated surveys and on-site inspections of its suppliers. The Bank also undertook target
investigations of the financial market's payment systems and infrastructures.
As I recalled in the last Concluding Remarks, some crypto-assets are not backed by any real or
financial assets. They have no intrinsic value and are subject to very high volatility, as the episodes
we have recently observed have indeed shown. Other crypto-assets are, instead, backed by real or
financial assets. If these assets are duly regulated and issued by clearly identifiable entities, they
could also potentially be useful, under specific conditions, as a means of payment. They can also
be distinguished by differing levels of transparency, liquidity of reserves, and disclosure of their
valuation processes. They are, however, suitable for regulation within a system similar to that
applied to more traditional instruments that perform a similar function.
The time needed to introduce new rules is not always compatible with the rapid dissemination of
new technologies. While waiting for the subject to be at least partly regulated by European
legislation (on which a first agreement at a political level has been reached in the last few days),
we recently published a communication on our website explaining the necessary conceptual
distinctions, alerting the public to the possible risks, and giving professional operators some
indications of possible safeguards to reduce these risks. We will continue to work together with
the other supervisory authorities, and with Consob in particular, to contribute to putting
regulations in place at all levels and to applying them in practice, with the aim of promoting
genuine innovation and avoiding the dangers arising from the less than genuine variety. This is a
task that will become more complex in the near future because it will involve the construction of a
comprehensive informational and analytical framework.
Last November, we disclosed the results of our in-depth analysis of the characteristics and risks
associated with the development of open banking, through which banks can now share customer
information with third parties if those customers are in agreement. Although the use of these
services is still relatively limited, the number of providers involved is not negligible. Technological
risks for intermediaries, including those arising from possible cyber attacks, are matched by the
need for adequate customer protection and for safeguards against money laundering. This is of
particular importance at a time when new technologies are being developed and put into use.
Further problems could arise from the establishment of third parties outside the European Union.
The ECB is about to communicate the results of the climate-related stress test exercise conducted
on a sample of 104 significant banks (of which 10 are Italian). Along with the thematic review,
deep-dive analyses of commercial real estate exposures and future targeted inspections, the
exercise contributes to the ongoing dialogue between supervisory authorities and intermediaries
to strengthen their capacity to manage this new type of risk.
This exercise is unlike those previously conducted since, in addition to making the classic
projections, it also involves collecting a vast amount of qualitative and quantitative information on
data availability, on the level of preparedness of banks in designing appropriate scenarios and
conducting climate-related stress tests, and on how the results are integrated into their business
strategies. The intermediaries have provided a large amount of data and information, but much
work remains to be done to fully take account of the effects of climate change in their models and
their medium and long-term development plans. As a supervisory authority, we will continue to
advise banks along this path, providing them with clear guidance and verifying that it is followed
precisely.
The banks' unwavering commitment to the prevention and combating of money laundering is
essential to ensure both the integrity of the financial system and the sound and prudent
management of intermediaries. Banca d'Italia regularly asks supervised entities to monitor
developments and emerging risks.
Alongside traditional risks, connected, for example, with tax crimes and corruption, n