Italian Banking Association
Annual Meeting
Speech by the Governor of the Bank of Italy
Ignazio Visco
Cyclical conditions and the economic outlook
In Italy, as in the other main advanced economies, economic activity slowed in the
early months of 2018, with the signs of deceleration continuing in the spring. The confidence
of households and firms has nonetheless remained high, with positive indications also coming
from the expansion of bank lending and improvements in the labour market. Although
unemployment is still above 10 per cent, employment has surpassed the peaks observed prior
to the double-dip recession. In more recent months, both the fixed-term and, to a lesser extent,
permanent components have recorded increases.
In most of the forecasts made by national and international institutions, Italy's growth is
expected to exceed 1 per cent on average in the three years 2018-20. This scenario assumes
monetary policy will continue to be accommodative and financial conditions relaxed, and that
there will be a favourable economic environment worldwide. In recent months, however, there
has been a notable increase in the risks connected with the United States' protectionist policies
and with disagreements on various fronts in relations between EU countries.
Last June the Governing Council of the European Central Bank recognized the progress
that had been made towards a sustained increase in inflation rates in the euro area - progress
associated with increased employment, greater use of productive capacity, accelerating wage
growth, and the recovery in inflation expectations. Though acknowledging that there are still
ample margins of uncertainty, it was decided to recalibrate the asset purchase programme and
in any event to maintain an ample degree of monetary accommodation in order to achieve the
objective of price stability.
If cyclical conditions in the area remain consistent with the current medium-term
outlook, from October net asset purchases of securities will be reduced from the current €30
billion a month to €15 billion and will cease at the end of the year. The principal payments
from maturing securities will continue to be reinvested for an extended period of time after the
end of the net asset purchases. The Governing Council also said that it expects to keep interest
rates at their present low levels at least through the summer of 2019. This prudent approach is
also necessary to counter the risk of sudden surges in long-term yields and of volatility in the
financial markets.
Given the prospects of growth and of a steady rise in inflation, Italy is in a position to
weather the gradual changes in the tone of monetary policy. The high average residual maturity
of the public debt, low household debt, reduced business debt, and the fact that banks are
sounder and have only limited exposure to the effects of any interest rate rises, will make it
possible to contain the risks connected with the structural fragilities of Italy's economy.
The achievement of a satisfactory and stable growth rate is, however, hampered by
continued weak productivity growth, the inefficiencies and rigidities of the business
environment and the high debt-to-GDP ratio. Addressing these vulnerabilities means
continuing to implement systematic reforms and balanced fiscal policies, which are also
necessary to maintain the confidence of households, firms and investors.
Recent tensions in the Italian financial market demonstrate the importance of a prudent
and balanced economic policy stance. Between mid-May and early June, with very low market
liquidity, yields on government securities increased across all maturities. Yields on ten-year
bonds surpassed 3 per cent for a few days and the spread with respect to the equivalent German
bond rose above 300 basis points, while the spreads vis-à-vis the government bonds of the
other euro-area countries also widened. The performance of premiums on credit default swaps
on government securities shows there were moments when fears of a redenomination of Italy's
debt grew among financial operators. Contrary to what happened at the height of the sovereign
debt crisis in 2011-12, the markets did not perceive this to be associated with an increase in the
risk of a euro break-up.
Pressures eased in the following weeks, when the sharp rise in volatility partially
subsided and short-term yields declined, restoring the more usual, positive slope of the term
structure. The spread between yields on ten-year Italian and German government bonds has
fallen to around 240 basis points; however, it is still more than 100 points higher than the
levels prevailing in the first half of May.
Maintaining orderly conditions on the government bond market is essential to defend
the stability of the financial system and effectively protect the savings of Italians. During the
tensions at the end of May, share prices in the banking sector declined sharply. The financial
situation of the public sector can influence that of the banking sector through multiple
channels. The reduction in the value of government securities held by banks directly affects
their assets; it also diminishes the amount of collateral that banks can use in Eurosystem
refinancing operations. The challenges for the public finances can lead to an overall
deterioration in the creditworthiness of firms, impairing the quality of bank loans.
It would be illusory to think that the link between sovereign risk and banking risk can
be broken with measures that push banks to drastically reduce their direct exposures.
Moreover, in the most difficult years of the crisis, Italian banks, like those of other countries,
swam against the tide, and made a profit, buying government bonds when tensions rose and
yields increased. When the conditions changed, they began to sell them. Last May, Italian
banks held slightly more than €300 billion worth of domestic government bonds in their
portfolios, compared with the €400 billion reached at the beginning of 2015.
Loan quality
The continued economic growth has led to a gradual improvement in the quality of
bank credit. The ratio of non-performing loans, net of loan-loss provisions, to total loans
system-wide, which had fallen by about 4 percentage points between the peak of 2015 and the
end of last year, decreased by almost 1 percentage point more in the first quarter of this year, to
stand at 5.3 per cent. The total amount of net NPLs fell to just over €110 billion, down from
€200 billion at the end of 2015. About half of the amount comprises exposures classified as
unlikely-to-pay, some of which could become performing again. For the less significant banks
the share of all NPLs (7.1 per cent) remains higher than that recorded by the significant
banking groups (5.1 per cent).
The development of the secondary market is making an important contribution to
reducing the number of NPLs. This market in turn benefits from the state guarantee on senior
debt issues deriving from the securitization of bad loans (GACS). The gross value of the bad
loans securitized under the GACS system was approximately €32 billion and it is expected to
increase considerably in the months to come. In the last few days, the Government has asked
the European Commission to extend the possibility of using GACS beyond the current deadline
of September.
The improvements made thus far should be consolidated and strengthened. More active
NPL management on the part of banks remains fundamental, including in the light of the
regulatory changes proposed by the European Commission and the new supervisory
expectations of the Single Supervisory Mechanism supplementing the guidelines on NPL
management published in March 2017. The strategies proposed by the banks will be assessed
on a case-by-case basis as part of ordinary supervisory activity and the measures best suited to
reduce the level of NPLs further and to gradually and sustainably adjust the level of
provisioning will be adopted. Account will be taken of the fact that the containment of a credit
portfolio's inherent risk must be compatible with the ability to absorb any potential losses from
sales.
The number and size of firms specialized in credit recovery are increasing, but the level
of competition in this sector remains unsatisfactory. Some banks have set up ad hoc units.
Progress in developing a liquid secondary market for NPLs and advances in the efficacy of
recovery procedures depend on a marked improvement in the quality of the information needed
for due diligence purposes and the timely monitoring of the status of the procedures. The
analytical reporting on bad loans launched two years ago by the Bank of Italy is making
significant strides in this direction. There is still ample room for improvement, however,
especially for small banks and with regard to data on real estate appraisals. Every effort must
be made to catch up.
Measures to increase the probability that likely-to-fail exposures return to performing
status must be stepped up. Their success requires different technical skills and operating
procedures from those used to manage bad exposures. A market for this type of exposure
should also be established and banks should actively seek agreements with turn-around funds
to offer firms the managerial and financial resources needed for a re-launch.
In recent years there have been improvements in the length of judicial credit recovery
proceedings as well. Data on the initial phases of foreclosure proceedings indicate that the
2015-16 reforms are working towards reducing their duration: the length of the pre-sale phase
has fallen by about a tenth (from 27.5 to 24.5 months), while that of the sale phase has been
nearly halved (from 41.5 to 23.5 months). Nonetheless, overall recovery times remain long.
Additional regulatory reforms may be needed to prevent the accumulation of NPLs on banks'
balance sheets and to ensure the necessary flow of loans to households and firms.
The enabling law reforming the regulations on corporate crisis and insolvency approved
by Parliament redistributes the competencies of judicial offices in the context of bankruptcy
proceedings in order to increase the level of specialization of judges. It overhauls the
courtbased liquidation procedure: priority must be given to significantly reducing the length of the
proceedings by simplifying the process and offering appropriate incentives to the parties
involved.
The judicial system can also be improved by introducing organizational changes, as the
wide variations in the duration of foreclosure proceedings in different courts suggest. The
guidelines approved last October by the Superior Council of the Judiciary, designed to
encourage the spread of best practices, could make an important contribution in this regard.
Additional benefits may come from the imminent launch of the electronic register for
foreclosure and insolvency proceedings and crisis management tools. These projects, to which
the Bank of Italy is contributing, are at an advanced stage.
In addition, the value of extrajudicial credit recovery instruments should not be
underestimated. In 2016 the Marciano Pact was introduced in Italy, which provides for the
transfer of ownership of real property serving as a guarantee to a business loan in the event of
default. However, recourse to this instrument remains limited. The agreement entered into by
ABI and Confindustria at the start of this year may encourage its use. The Pact's importance
has been confirmed by the initiatives under way at European level as well. The European
Commission recently presented a draft directive which, among other things, provides for an
expedited procedure for the out-of-court enforcement of real property guarantees in the context
of business loans that is similar to the Marciano Pact.
Recent reforms
In recent years, the difficulties faced by some small banks have been resolved through
acquisitions by other banks, with Italian or foreign financial intermediaries and investors
participating in the capital and with the contribution of the voluntary scheme of the Interbank
Deposit Protection Fund. In a market in which technological innovations make bank branch
networks less attractive to potential investors, crisis resolution has become more difficult.
European regulations preclude the use of the resolution tool for small banks, on the assumption
that it is not in the public interest to do so. Therefore, in the absence of interested purchasers,
there would be no alternative but to liquidate these banks. The impact, even reputational, on the
entire category of small banks would be significant.
Good corporate governance and access to the capital markets are indispensable for
avoiding a crisis. In turn, adequate skills and rigorous monitoring of conflicts of interest are
needed for high-quality governance. It is a short step from being a bank that 'supports local
interests' to being a bank that is 'trapped by the region'. Virtuous examples of local banks are
possible, but they call for high-quality organizational structures and thorough and prudent
credit assessments. Recent experience has shown that these operational models can be achieved
if local expertise is accompanied by the use of adequate quantitative instruments (such as credit
scoring systems) and if high levels of productivity are maintained.
Different forms of integration can help in strengthening small and medium-sized banks:
outsourcing and sharing certain functions and services, creating specialized purchasing
consortiums, and using institutional protection schemes. For small banks, however, the merger
or creation of a banking group remain the most effective tool for improving efficiency and
guaranteeing market access for recapitalization purposes.
In recent years, the governance structure of cooperative banks has been the subject of
major reform measures. The reform of the popolari banks has allowed institutions that had
grown significantly in size - some of which listed - to take on the legal form that best
represents their actual business structure. The governance problems inherent in the cooperative
model would have continued to hamper their access to the financial market, especially when it
is necessary to rapidly strengthen capital. The transition to joint stock company makes it
possible to carry out mergers that would otherwise be difficult to execute, with benefits for the
entire banking system. The reform must be seen through to the end so that the remaining large
popolari banks can make the necessary improvements regarding the transparency of their
governance structure, the ability to access the market, and the possibility to participate in
mergers.
Italy's smaller popolari banks, whose transformation into joint-stock companies was
not mandatory under the reform, could also benefit from increased integration in some areas
such as the pooling of production processes and marketing of their products. Some headway is
being made in this direction and must continue. In this year's Concluding Remarks I also raised
the possibility that these banks could take advantage of special institutional protection schemes
based on agreements to provide reciprocal guarantees on the solvency and liquidity of their
members, along the lines of similar schemes in other European countries, with benefits when it
came to calculating capital requirements. This is an opportunity that merits serious
consideration.
The reform of the mutual banking sector (BCC banks) is proceeding as the law requires.
In the next few weeks, the supervisory authorities will adopt measures authorizing the creation
of the new cooperative banking groups. Within ninety days of obtaining authorization, the
shareholders of the BCCs must approve the amendments to their by-laws and sign the cohesion
contract regulating the degree of business autonomy of each individual bank by means of a
system of risk assessment. The process of drafting the reform, which garnered broad consensus
throughout the sector, took almost two years to complete. The discussions between the
supervisory authorities and future parent banks on preparing the applications to create the new
banking groups have been intensive. The reform preserves the banks' cooperative and
mutualistic spirit, even within the new regulatory and market environment. Precisely in order
to pursue these objectives the law envisages that the BCCs will be majority stakeholders of the
new parent banks.
As members of a banking group, BCCs can tap capital markets in times of need,
warding off potential crises. They can share best practices and centralize key oversight and
production functions, with cost and revenue synergies that individual members can exploit
while maintaining a relatively small scale of operations. The pooling of horizontal functions
means BCCs could focus on developing their regional presence, with benefits for local
economies and customer bases. Even the most 'virtuous' of these banks could raise their
current efficiency levels; businesses and shareholder/customers could gain access to a broader
range of products and services. The system of joint and several guarantees would allow the
weakest BCCs to take effective and timely action to overhaul their business models, both in
terms of their capital positions and the range of services offered to firms and households.
Capital adequacy and profitability
During the crisis, even when market conditions were especially harsh, Italy's banks
undertook significant capital strengthening. The CET1 ratio, which today stands on average at
just below 14 per cent, has almost doubled since 2008. The increase was achieved together
with the introduction of stricter rules on minimum capital requirements (Pillar 1) and
supplementary requirements by supervisors (Pillar 2) to counter risks not covered under the
first pillar.
The conclusion, to all intents and purposes, of the Basel III agreement at the end of last
year reduced the regulatory uncertainty surrounding the long and complex process of drafting
the measures that were first announced and then gradually adopted by the Basel Committee.
The progressive application of the rules over a period of five years, from 2022 to 2027, allows
banks to plan the necessary changes well ahead of time. The transposition into European law of
the agreement finalized a few months ago in Basel has just begun. The Commission has called
for the EBA's technical advice in setting out the procedures for implementing the new
international rules, taking account of European specificities and of the need to uphold the
principle of proportionality in their application to small banks.
The impact of the new rules on Italy's banks appears modest overall. Recent estimates
on a sample of the largest banks suggest that once fully implemented, the CET1 ratio will be
lower by around 70 basis points, as against the EBA's estimate of 140 points for the leading
European banks. The impact would mostly derive from the treatment of operational risk; the
rule on the minimum requirement for banks that use internal models (known as the 'output
floor') is expected to have a very limited impact in Italy. This could be reduced further by the
steps that the banks will certainly take to adapt to the new rules during the long transitional
period prior to full implementation. Banks must make good use of the time available before the
introduction of the new rules. Measures to strengthen their balance sheets and improve
profitability are fundamental, continuing the action undertaken in recent years.
In the first three months of this year, the profitability of Italy's largest banks improved,
continuing the trend observed in 2017. For the significant institutions, annualized ROE rose to
8.4 per cent, from the 5.1 per cent recorded in the first quarter of last year; the cost-to-income
ratio fell by around 5 percentage points, to 65 per cent. The average profitability of the less
significant institutions is lower: in 2017, the last period for which complete data are available,
their ROE amounted to 1.3 per cent, against 4.7 per cent for the significant institutions.
For all the banks, and especially for small banks, successfully meeting the challenges
posed by stronger competition, regulatory pressures and new technologies, requires incisive
action to increase operational efficiency. The reform of the mutual banking sector, which I
mentioned earlier, is one of the responses to these challenges. But undoubtedly more must be
done, especially in relation to technological change.
With the advent of Fintech, marking the marriage of high tech and high finance, the
framework of reference is changing rapidly. New players are creating alternative and more
efficient business models, often superseding functions traditionally carried out by banks, such
as the provision of payment, asset management and securities investment services. Based on
market analyses, traditional banks believe that, over a five-year horizon, a number of their
activities, corresponding to around a quarter of profits, are at risk.
Compared with the new entrants, incumbent banks enjoy advantages stemming from
stable relationships with customers and the wealth of data collected over the years. By
exploiting these advantages better through the use of new technologies, they can expand the
range of services offered, improve the quality of relationships with customers and manage risks
more effectively. Investment in this area remains low and is mostly made by the largest banks.
This is due to difficulties in adapting organizational arrangements and operational processes,
identifying the necessary skillsets and integrating systems with pre-existing technological
infrastructures. If the potential of Fintech is not exploited in full, banks run the risk of rapidly
losing ground with respect to new operators that are often subject to lower regulatory
requirements and to the technology giants that have already emerged in the fields of banking
and finance.
Against this background, the banks now have to restore efficiency ratios and bolster
profits by diversifying their sources of revenue and reducing administrative and labour costs,
particularly those associated with a widespread network of branches located around the
country. In what is now a mature market, in Italy as in the other European countries, a new
phase of banking concentration could help to exploit economies of scale and absorb excess
capacity.
Efforts to realign the structure of the market have been under way for some time: in the
last two years the number of banking groups and independent banks has diminished by about
100, to a total of just over 400, and it will fall further with the creation of cooperative banking
groups. By the end of last year, the number of bank branches was down to 27,000, from 29,000
in 2016 and 35,000 at the end of 2008. Between 2008 and 2017, employee numbers have
dropped from 338,000 to 282,000. The process of restructuring the market must go on; in 2017
the number of bank branches per 10,000 inhabitants averaged 4.2 in the Eurozone and 4.5 in
Italy and their productivity, measured by the ratio of balance sheet assets to number of
employees, was €15.2 and €13.2 million respectively.
Efficiency and profitability also need to be restored in order to meet the new
requirements for loss-absorbing liabilities in case of failure (MREL), as these could lead to a
sharp increase in the cost of wholesale funding at a time when the size of renewals could be
significant. Indeed, about half of the present stock of outstanding bonds, amounting to almost
€150 billion, will mature before the end of 2020. It is important to take into account, as well,
the implications of the on-going review of internal models for measuring solvency capital
within the Single Supervisory Mechanism, which could lead to higher requirements.
Sufficient profit margins and suitable capital cushions have also become necessary in
view of the periodical stress tests that the banks are required to run and that the supervisory
authorities use to assess the institutions' ability to withstand adverse macroeconomic scenarios.
A new stress test is now being conducted in Europe on the leading banks, coordinated by the
EBA and run by the SSM in the countries of the banking union. The results will be published at
the beginning of November.
The other measures that banks should take to improve efficiency and diversify sources
of revenue - and which include offering a broader and better defined selection of asset
management services - cannot be governed by opportunistic considerations or shaped by the
temptation to exploit privileged positions. Customer centrality, which underpins EU legislation
on financial investments (MiFID II) and the guidelines issued by the European regulatory
authorities, is key to ensuring the sustainable development of the banking industry. Banks
should be encouraged to create and market products and services geared to meeting customers'
new demands or improving the response to existing needs, taking advantage of the possibilities
offered by new technologies. Compliance with the rules introduced to promote customer
relations based on transparency and probity, on the one hand, and constant monitoring of
potential conflicts of interest, on the other, continue to underpin the protection of savings.
* * *
The reforms launched in Italy and in the rest of the EU to reduce the elements of
fragility exposed by the global financial crisis and the sovereign debt crisis have yet to be
completed. Willingness to pursue the path taken has gradually weakened; in Europe, some
countries have become concerned about the distribution of the costs and benefits of the
measures needed to improve the EU's economic governance; in Italy, the reforms have lost
impetus owing to fears about their cost, often borne in the short term, and doubts about their
benefits, which will emerge gradually and only in the fairly long term. In such conditions, if
faced with a new crisis, we will be far more vulnerable now than we were ten years ago.
There remain some fundamental aspects of the banking union that need to be finalized,
such as the resolution fund - still without sufficient coverage - and the deposit insurance
scheme - yet to be instituted. The new rules have eliminated the national tools for managing
banking crises, but they have not replaced them with effective common mechanisms. A similar
situation overshadows the public finances: individual countries saw their scope for manoeuvre
further reduced when their debt increased after the recession, but no start has been made on
creating a pan-European macroeconomic stabilization capacity.
Europe needs to overcome the division between those who believe the risks should be
reduced and those who maintain they should be shared more equally, a division that has a poor
analytical background and serves little political purpose. We can in fact reduce the risks by
sharing them: the completion of the banking union and the introduction of a real union of
capital markets are a precondition for eliminating financial fragmentation and allowing private
capital to act as a shock absorber as it does elsewhere, for example in the United States. A
European budgetary capacity would limit the impact of recessions in single member states
without weighing on national public finances, thus reducing the risk of sovereign debt crises
and the need for rescue measures, which, as experience has taught, are extremely costly.
At the same time, it is essential to continue resolutely and visibly reducing the risks in
each country in order to win the trust of savers and markets alike. This process needs to be
carried out carefully and gradually, however, to avoid creating a breeding ground for new
crises, particularly given the lack of a common safety net, and so oblige the countries
concerned to adopt overly restrictive budgetary measures while making it impossible for the
banks to adequately support the economy.
We must not cease our efforts to strengthen Italy's banking system, particularly the
smallest institutes, and to eliminate the structural impediments to realizing our economic
growth potential. The banks should provide the financial services that will allow firms to grow
and innovate, but a system that is able to grant credit justly and efficiently, even in adverse
economic conditions, needs its residual competitive disadvantages to be removed. This is one
of the objectives of the action being taken to improve the efficiency of judicial and
administrative procedures; we must not stop now.
The obstacles to business, innovation and the correct allocation of resources caused by
rigidities and delays in public services should also be eliminated. And there is clearly a need
for public investment, chosen and carried out with the utmost efficiency, just as there is also
need for sweeping and balanced fiscal reform to increase employment and promote economic
growth.
In such a situation, demand-side policies should be carefully gauged, focusing on public
accounts balance and the importance of monitoring the debt-to-GDP ratio. It would be
dangerous to rely on such policies alone to help Italy escape the trap of low growth in which it
has been confined for so long and resume a path of strong and lasting development. Caution
and farsightedness are essential to avoid tensions or potential crises and to prevent Italy's
future generations from inheriting higher debt and lower income.
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