Ignazio Visco: Fact-finding inquiry on the Italian banking and financial
system and the protection of savings, also regarding supervision, crisis
resolution and European deposit insurance
Testimony by Mr Ignazio Visco, Governor of the Bank of Italy, before the Sixth Standing
Committee (Finance and Treasury) of the Italian Senate, Rome, 19 April 2016.
* * *
The macroeconomic context and its impact on banks
From 2008 to the present day Italy has been buffeted by the worst economic crisis of the
post-war period.
The trouble started with the explosion of defaults in the US subprime mortgage sector and
soon spread to the markets for several complex and difficult-to-value assets, dubbed "toxic"
When it became apparent that several European banks - but not Italian ones - also had
considerable exposure to these instruments, the euro-area interbank market all but
collapsed.
Then came Europe's sovereign debt crisis, which originated in Greece and rekindled the
financial crisis. Beginning in the summer of 2011 the tensions spread to Italy; the further
contraction in international interbank lending was countered by the ECB's extraordinary
refinancing operations. Interest rates on Italian government bonds soared far above those of
the corresponding securities in other euro-area countries, especially Germany. Only with the
announcement, in the summer of 2012, of exceptional monetary policy measures designed
to combat unjustified and excessive market rate rises in the euro area did the tensions begin
to subside. Inevitably, however, they had already been transmitted to the banking market
and, coupled with the drying up of the wholesale funding market, led to a sharp increase in
the cost of credit and a consequent thinning of supply. This, in turn, exerted a brake on
manufacturing activity which lasted over three years and was compounded by unresolved
structural problems in Italy's economy.
Europe is now slowly exiting the crisis. The recession's legacy is especially heavy in Italy: the
loss in real GDP compared with the pre-crisis peak amounts to around 9 percentage points,
while industrial production has shrunk by about a quarter; in the euro area as a whole, output
has generally held steady and industrial production has contracted by around 10 per cent,
much less than in Italy.
Developments in national banking systems have closely mirrored those in the respective
economies. In the first phase the crisis hit the systems that were exposed to toxic assets: the
United States, the United Kingdom, and a number of euro-area countries. The result was
widespread bank failures, countered by large-scale state support.
Italy's banking system, which was not exposed to toxic assets, emerged almost unscathed
from the early stages of the crisis. It was, however, profoundly shaken by the deep and
prolonged recession. In those years Italian banks, whose main business consists in lending
to firms, recorded heavy loan losses: in the period from 2008 to 2015 these totalled about
€200 billion, eroding 73 per cent on average of operating income.
The banks responded with large capital increases. At the end of last year, the ratio of their
core equity capital to risk-weighted assets reached 12.3 per cent, compared with 7.1 per cent
in 2007. The average capitalization gap with respect to European banks as a whole, whose
core equity ratio was 13.6 per cent at the end of last year, also reflects the massive
recapitalizations with public money that occurred in several other euro-area countries.
All in all, Italy's banking system proved resilient. This was confirmed by the IMF in
September 2013, in the foreword to its Financial Sector Assessment Program (FSAP), in
which it gave a favourable judgment on Italy's supervisory system.1
The Bank of Italy's supervisory action
Banks specializing in traditional retail services - as is the case in Italy - are more vulnerable
than others to periods of recession, especially if deep and prolonged. The exceptional
contraction of the Italian economy has dented banks' earnings capacity and saddled them
with a large volume of non-performing loans, reflecting widespread business failures and the
decline in employment. When, as occurred on a number of occasions, the repercussions of
the crisis were aggravated by imprudent policies or episodes of mismanagement, the
deterioration of banks' assets became critical.
In this difficult context, the Bank of Italy's supervisory action prevented the onset of a
profound and system-wide banking crisis. Where necessary, it adopted corrective measures
within the scope of the powers conferred on it by law. Only with the transposition of CRD IV
in 2015 did these powers become more incisive, making it possible to remove individual bank
executives or to impose changes in management and control bodies, powers which the Bank
of Italy had long advocated and whose absence had been heavily criticized by the IMF. For
the long period in which these powers were lacking, moral suasion took their place, albeit
with the objective limits this entailed.
Well before the launch of the single supervisory mechanism in November 2014, the Bank of
Italy called on credit institutions to strengthen their capital bases and make their balance
sheets more transparent. Inspections of write-downs of non-performing loans at the main
banks in 2012-13 partly determined the adoption of stricter provisioning policies and the
consequent raising of these loans' coverage ratios. This restored the credibility of the largest
intermediaries when they turned to the market to raise capital. The capital resources raised,
in excess of €40 billion from 2008 onwards, allowed banks to comply with increasingly strict
rules even in adverse economic conditions. Calls for capital strengthening were flanked by
robust corrective action on corporate governance, risk measurement and control
methodologies, and internal controls.
Taken together, these measures enabled Italy's banking system - with just a few exceptions
- to pass the European-wide comprehensive assessment. But even constant, incisive
supervision cannot prevent the outbreak of financial ills, especially in a fragile economic
environment.
Italian and European law and the prudential supervisory model successfully ushered in by
the Basel Committee promote the business independence of banks. Bank executives take
most of their decisions without prior supervisory control; they are responsible for their actions
first and foremost to the shareholders. The supervisory authority cannot systematically
encroach on their decisions, even when they adopt imprudent or short-sighted policies.
Banks are businesses, after all. They are subject to market forces; their directors must be in
a position to take fully independent decisions.
The success of supervision in preserving sound and prudent management depends on many
factors, not least the full transparency of directors, management and shareholders in their
dealings with supervisors. However widely it has exercised its powers of sanction and
notwithstanding numerous reports to the judiciary, banks have not always reacted promptly,
nor have the corrective measures adopted always been sufficient. Rash and occasionally
fraudulent behaviour by top management are also partly to blame for the deterioration in
banks' situation.
Supervision aims to reduce the likelihood of a crisis occurring and to mitigate its
consequences. As a rule anomalies and irregularities emerge or are confirmed following
indepth inspections. Whenever they have been identified, the Bank of Italy has acted with the
maximum determination. Any suspected criminal acts have been reported immediately to the
public prosecutor's office. The situation has not changed with the entry into effect of the
single supervisory mechanism; the inspections of the banks classified as significant,
including those that brought to light the irregularities at the two former popolari banks, Banca
Popolare di Vicenza and Veneto Banca, were conducted by the Bank of Italy's inspectors,
and the schedules for the investigations and any subsequent interventions were drawn up in
full agreement with the Bank of Italy.
Identifying irregularities or illegal acts is neither easy nor automatic. There is a widely held
belief among the public that the Bank of Italy's supervisory and investigative powers are
limitless. On the contrary, pinpointing anomalies that are sometimes carefully concealed
requires painstaking in-depth analysis and finely-tuned investigative techniques, such as
confiscations and searches, which are exclusively judicial powers.
Despite this, the Bank of Italy's supervision has dealt decisively with problem banks, enabling
them to repair imbalances in their economic and financial situation. Most of these cases are
not known to the public at large: with few exceptions, the Banking Law stipulates that any
news, information or data that is acquired by the Bank of Italy in the course of its supervisory
activities is covered by professional secrecy.
In some instances (Banca Monte dei Paschi di Siena, Banca Carige and, more recently,
Banca Popolare di Vicenza and Veneto Banca), given the banks' poor economic and
financial conditions, weak liquidity positions, and grave irregularities, restoring the necessary
conditions for staying in business required a radical shake-up of directors and management
and substantial capital increases, some of which are now being finalized.
For an analysis of specific aspects relating to these banks' conditions and a detailed
description of the supervisory action undertaken by the Bank of Italy, please consult our
website.2 For now, I will limit my observations to the following main points.
Over the years the Bank of Italy's inspections of Monte dei Paschi di Siena examined all the
main areas of operation: capital adequacy, liquidity position, financial risks, performance of
the Italian government bond portfolio, credit quality, and the adequacy of management and
internal control bodies.
Little by little, as the off- and on-site inspections began to pinpoint problems and shortfalls,
the Bank of Italy intervened with increasing forcefulness. In November 2011 this culminated
in the summoning of the top executives of Monte dei Paschi and its Foundation (the principal
shareholder at the time), who were asked to implement rapid and sweeping change,
something that came about in the months that followed with the appointment of a new
Managing Director and the replacement of the majority of the members of the Board of
Directors and Board of Auditors, as well as a major management shake-up.
As is well known, the bank's previous management had failed to transmit to supervisors the
information that was vital for a full recognition of the scale and nature of several operations
that had been carried out in violation of the law. The Bank of Italy imposed heavy sanctions
on those responsible and brought the case to the attention of the judiciary, to which it offered
its full cooperation.
All in all, the actions taken enabled anomalous high-risk practices to be identified and
brought to an end, impelling Monte dei Paschi di Siena to reinforce its organizational
safeguards and controls. The bank continues to be closely monitored nonetheless. The
supervisory review and evaluation process (SREP) for 2015 highlighted the persistence of
several weaknesses, most importantly the share of non-performing loans. This was partly
due to the highly expansionary lending strategy pursued before the crisis, which the bank is
now actively addressing. Structural solutions have also been called for, such as mergers with
other credit institutions.
In the case of Carige, in recent years the Bank of Italy's supervisory activity focused on the
group's weak capital position, which failed to meet the highest standards of Basel III that
were about to be introduced, the progressive deterioration in the quality of its loan portfolio,
and malfunctions in corporate governance arrangements and controls.
The inspections conducted in 2013 confirmed these weaknesses and brought to light further,
more clearly detailed issues, such as the existence of conflicts of interest on the part of the
group's top management. They also stressed the need for decisive and timely intervention to
make a clean break with the past, enabling a proper rebalancing of corporate governance
powers and the adoption of strategic repositioning and capital strengthening plans. Following
the inspections, sanctions were applied and the public prosecutor's office informed.
The new top executives appointed at the end of 2013 launched a restructuring plan in line
with the requests advanced by the supervisory authorities. Despite the results obtained, the
volume of non-performing loans remains substantial and, as for other banks, the
unfavourable macroeconomic context continues to pose major challenges to earnings.
Events at the two former popolari banks came to the public's attention when there were new
reports of inquiries launched by the judiciary, with which the Bank of Italy had been
cooperating for some time. In the debate that ensued the Bank of Italy's actions were
repeatedly called into question, often based on mistaken premises or fundamental
misunderstandings.
In the case of Banca Popolare di Vicenza, most of the criticism was directed at the price of
the shares and their funding by the bank.
On the first aspect, it is important to specify that Italy's Civil Code assigns responsibility for
setting the price of shares to the general shareholders' meeting, which votes on a proposal
by the Board of Directors. The Bank of Italy has no direct power in the determination of share
prices, although it is entitled to question the reasonableness of the procedures followed and
the objectivity of the criteria adopted to set the price, which it did. Given the exclusive power
of the management bodies in this instance, the Bank of Italy could only advance
methodological criticisms but not value judgments. The Banca Popolare di Vicenza did too
little for too long and its underlying inertia over the corrective action was therefore
sanctioned. Only in 2011 did it issue guidelines for fixing the share price, using an external
consultancy service to do so. As a result, the price stayed unchanged for several years
before being drastically reduced (as had already occurred for the shares of other listed
banks) following findings originating from the anomalies that had emerged in trading in own
shares.
Regarding this second aspect, in 2013 supervisors intervened on several occasions to
remind Banca Popolare di Vicenza of its duty to comply in full with the prudential limits
envisaged by law before 2014 and to call to its attention the need to not generate among
shareholders expectations of certain and immediate liquidity of their holdings and guaranteed
minimum returns.
In the course of 2014 it emerged that the bank was buying its own shares without having first
sought the necessary authorization. In accordance with the new European supervisory
setup, the Bank of Italy planned a targeted inspection for early 2015 to verify these operations.
The inspection was again conducted, within the single supervisory framework, by Bank of
Italy staff. In addition to revealing unauthorized share buy-backs by Popolare di Vicenza, it
highlighted a further problem with the funding of the shares issued in recapitalizations: the
bank had not deducted from the supervisory capital the funds raised against the substantial
loans it had disbursed to subscribers of its shares, as instead required by prudential
regulations.
Already after the initial findings of the inspection the bank had been called on to take
corrective measures, including a virtually complete change of management. Once the
inspection had been completed the bank was ordered to restore capital adequacy buffers to
regulatory levels, draw up a new business plan, and strengthen its organization and internal
control functions. In accordance with the new business plan, the bank then passed a
resolution approving a comprehensive plan to strengthen its capital and radically overhaul its
governance, including its transformation into a joint stock company, now completed, a €1.5
billion capital increase, and stock market listing.
In the case of Veneto Banca, an inspection carried out in 2013 found major anomalies of a
technical and administrative nature, highlighting the practice of disbursing loans to customers
against purchases of the bank's own shares, which were then not deducted from supervisory
capital. We did everything in our power: prohibited the bank from disbursing new loans to
corporate executives; called a meeting of the Board of Directors to examine the bank's
overall situation and pass the appropriate resolutions; read out to the meeting of
shareholders the official request for action to ensure that it was aware of the bank's situation
and of the measures taken by the Bank of Italy; and imposed fines on the persons
responsible.
At the same time, where it was not in our power to intervene directly, we used strong moral
suasion, calling on the bank to replace all of its management boards and to plan a merger at
the earliest opportunity.
The bank's response at the time was unsatisfactory. It did not make all the required changes
to its governance and continued to engage in conduct contrary to the principles of sound and
prudent management, such as granting loans to subscribers of the capital increase made in
2014, which emerged in the course of the follow-up inspection in 2015. Because of the
consequent reduction of supervisory capital and further rapid deterioration in the quality of
assets, the situation could only be remedied through a €1 billion capital increase, now under
way. The Bank of Italy's supervisory action, ensuring continuity with the past but now
endowed with more incisive powers under CRD IV, brought about the replacement of the
bank's president and most of its senior executives and is currently monitoring the
implementation of a more radical reform of corporate governance that began with the bank's
transformation into a joint stock company and will be completed with its stock market listing.
As regards other banks, delays and resistance on the part of the governing boards have
gone hand in hand with a marked worsening of their corporate profiles, particularly their
credit risk, and an unwillingness on the part of the market to provide capital support,
inevitably resulting in the appointment of a special administrator. This is the case of the four
banks placed under resolution in the month of November. Before discussing these banks in
greater detail I would like describe briefly the changes that have affected the management of
banking crises and determined how these situations are handled.
Changes to the framework for banking crisis management
Before 2015 the Bank of Italy's objectives in handling banking crises were to minimize the
impact on customers, the payment system, and the banking system as a whole. In many
instances, extremely fragile banks were taken over by healthier ones. When a bank was
likely to fail, special administration was set in motion and in the worst cases the bank was
wound up.
Special administration can only take place if the legal conditions for it are met; these include
serious violations of regulations, serious irregularities of management, and serious capital
losses. The definition of serious applies to irregularities and violations of the law which have
a wide-ranging impact on the bank's situation (for example, repeated violations of
antimoney-laundering legislation, serious and frequent conflicts of interest, and opaque
ownership structures), which must cease as soon as possible, and which the bank is unlikely
to be able to rectify on its own. Capital losses are considered serious when the regulatory
minimum capital adequacy ratios are not observed.
Special administration does not come out of the blue. As a rule, it is preceded by intensive
discussions with the Bank of Italy's supervisors, repeated attempts to remedy the situation,
and a number of inspections, the last of which usually ascertains that it is no longer possible
to restore normal business conditions or comply with capital adequacy ratios. This is what
happened in the case of the four banks for which a resolution procedure was activated and
for the others that were placed in special administration.
The latter entails the dissolution of the bank's administrative and control bodies and their
replacement by one or more administrators and a supervisory board. The administrators act
independently of the Bank of Italy, which only authorizes certain decisions of particular
importance. The functions of the shareholders' meeting are suspended until the procedure
comes to a close.
The administrators are charged with ascertaining the true situation of the bank, eliminating
irregularities and establishing the conditions to prevent their recurrence, as well as favouring
a solution to the crisis that is in the interest of depositors. The task of ascertaining and
eliminating the irregularities may take several months. The longest and most complex phase
is generally the search for solutions.
Since 2008 there have been 65 cases of special administration, most of them ending with the
bank's return to ordinary operation. In about 20 cases, the outcome was the compulsory
administrative liquidation of the bank, which occurred more frequently during the crisis. There
were no major implications for customers, however, as the failing banks' exit from the market
was managed either by finding other credit institutions interested in an acquisition or by
covering the losses with interventions by the Interbank Deposit Protection Fund or the Mutual
Bank Deposit Guarantee Fund. This last solution stemmed from the participating banks'
desire to avoid further outlays in the event of liquidation (the principle of least cost).
More recently, the economic crisis and the raising of prudential requirements have made it
rather impracticable to resort to mergers such as those that had helped in the past to
overcome bank difficulties without causing disruption. Moreover, the new European
regulatory framework has brought about some radical changes. In particular, the Interbank
Deposit Protection Fund's scope for action has been restricted by the European
Commission's Directorate-General for Competition, which now considers any intervention by
deposit guarantee schemes other than the reimbursement of deposits to be tantamount to
state aid, even though it is privately financed and decided independently by the fund's
management bodies.3
Following a Communication issued in August 2013, the D-G for Competition has made
intervention of this type conditional on burden sharing, whereby in the event of a bank's
failure the face value of its shares and subordinated bonds must be reduced or the latter
converted into equity before any recourse is made to public funds. Burden sharing is not the
same as the 'bail-in' principle, which was introduced on 1 January this year with the adoption,
in November 2015, of the Bank Recovery and Resolution Directive (BRRD). The bail-in rules
provide that, before the National Resolution Fund (or, more generally, public funds) can be
utilized, the face value not only of shares and subordinated bonds but also of senior claims
such as ordinary bonds and deposits of over €100,000 must be reduced. A bail-in respects
insolvency rankings: therefore, it is applied first to shares, then to other equity and
subordinated instruments, and then to unsecured debts, including ordinary bonds issued by
the bank in difficulty. Until the end of 2018, corporate unsecured deposits contribute to the
same extent.
The crises at the four banks subject to the resolution procedure
It is in this new context that the crisis of the four banks resolved in November last year was
managed. Details of how the four situations unfolded can be found on the Bank of Italy's
website, to which I refer you.4 On this occasion, I will confine my remarks to some of the
most widely debated aspects that require clarification.
The Banca delle Marche group had a number of weaknesses, mainly stemming from its
governance and control structures and poor credit quality. These problems emerged more
clearly from the three inspections conducted in rapid succession in 2010 and 2011. Based on
the findings of the inspection at the bank, major corrective measures were called for. When
an inspection at another bank brought to light anomalous transactions involving the
Managing Director, Banca delle Marche was asked in June 2012 to find a replacement as
soon as possible. At that time it was not in the Bank of Italy's power to remove bank
executives. A new Managing Director was appointed in September of the same year. Also in
view of Banca delle Marche's delay in implementing the corrective measures requested, at
the end of 2012 a new inspection was ordered to assess whether Banca delle Marche had
allocated sufficient provisions for credit risk. The bank's efforts to remedy the shortfall were
found to be highly unsatisfactory and in March 2013 the inspection was extended to other
risk profiles; it was brought to a close in September 2013. The findings were of such gravity
that the bank was placed first under provisional management and then on 15 October 2013
into special administration.
Inspections at the Carife group focused primarily on the level of risk of its credit portfolio and
on its capital adequacy. On more than one occasion the Bank of Italy's supervisory arm
reiterated the need for a reorganization of the group and a strengthening of its control
functions. Carife's liquidity profile was also closely monitored and the strains were only
overcome through the issue of government-guaranteed bonds. Owing to the delays in
making the corrections requested, at the end of 2012 a full-scope inspection of the group
was set in motion. Owing to the extremely serious nature of the situation that emerged -
there was no possibility of the group restoring the necessary economic and financial
equilibrium on its own in the short run - a special administrator was appointed in May 2013.
In 2010 and 2012 two inspections of the Cassa di Rispamio di Chieti group found problems
of disorderly growth, irregularities, and poor management. The Bank of Italy ordered the
subsidiary's merger into the parent group and the removal of the Chief Executive Office, who
also held the position of Managing Director of the Cassa di Risparmio di Chieti. The
supervisory action was then stepped up and the bank was invited on several occasions to
take strong measures to put the problems to rights. The feedback from the executives of
Carichieti indicated that they were largely unaware of the problems. It was therefore decided
in 2014 to conduct another inspection. This not only found a significant deterioration in the
bank's profitability and capital base but also revealed extremely serious irregularities and
regulatory violations, such as the persistent obscuring of information from supervisors,
serious administrative anomalies, lack of independence from the controlling bank Foundation
as regards decision-making processes, and negligent management of relations with
associated parties. Accordingly, on 5 September 2014 Carichieti was put into special
administration.
Following a series of delays in responding to the Bank of Italy's requests, an inspection of
Banca Etruria was launched towards the end of 2012. Initially, its purpose was to verify the
adequacy of the bank's credit risk provisions but in March 2013 it was extended into a
fullscope inspection. It ended in September 2013 having ascertained that the management
boards were unable to restore the bank to health and that there had been a considerable
deterioration in claims. The capital adequacy ratio was above the regulatory minimum thanks
to the €100 million increase made in August 2013. Hence, Banca Etruria was asked to take
resolute steps to remedy the problems, including the appointment of temporary management
and above all a merger with another bank of suitable standing. The Board of Directors, of
which half of the members, the Chairman and Deputy Chairman had been replaced, failed to
appoint temporary management and, citing the need to safeguard its local roots and ensure
the bank's independence, refused to entertain the only official offer of a merger made of its
own volition by Banca Popolare di Vicenza. The Bank of Italy increased meetings with senior
management, calling attention to the fact that the group would have difficulty in the future
ensuring compliance with capital adequacy requirements. As no solution was found, a new
inspection was conducted in November 2014, which identified serious capital losses and
serious irregularities. On 10 February 2015 the bank was put into special administration.
As a result of the various inspections carried out at the four banks, fines were levied on the
executives totalling more than €11 million. All the inspection reports were forwarded without
delay to the judicial authorities.
The administrators appointed for the four banks spent considerable time seeking market
solutions, contacting a number of banking groups and other intermediaries. However, owing
to the lack of interest in banks burdened with a large volume of non-performing loans and a
very low capital base, it proved impossible to find a solution involving mergers or
acquisitions. At this point the Interbank Deposit Protection Fund signalled its willingness to
take part in recapitalizations conducted by other banks.
However, the European Commission's position - which, as I mentioned earlier, likens the
intervention of the Fund to state aid - made it impossible to take up the offer. In fact,
because of the Commission's own rules, this interpretation would require burden sharing to
be activated first, that is the conversion of subordinated bonds or annulment of their value,
something not envisaged in Italian legislation until the implementation of the BRRD in
midNovember 2015.
It should be noted that had this step been taken without the approval of the European
Commission, trusting in a favourable decision by the Court of Justice, under accounting rules
it would have entailed allocations to provisions for the same amount as the intervention in
order to cover the consequent risk of legal action, completely cancelling its effect. The banks
willing to underwrite capital increases would never have participated owing to the uncertainty
and legal risks involved. Nor would the ECB, as competent authority, have authorized the
operations without the agreement of the European Commission.
The Commission, which has direct contact with the Italian Government and not with the
supervisory authority, set out its position on several occasions in the course of the technical
discussions but only formally notified the Italian Government on 19 November 2015.
According to this position, intervention by the Interbank Deposit Protection Fund to prevent a
"resolution" procedure under the BRRD was effectively limited to voluntary intervention by
the banks belonging to the Fund using resources other than the mandatory funds deposited
with it. However, the banking system was unable to organize such intervention in the short
time available, owing to the precarious liquidity situation of the failing banks. Moreover, the
imminent entry into force, in January 2016, of the bail-in scheme would have extended the
annulment of the value of customers' holdings to ordinary bonds and unprotected deposits
before the National Resolution Fund could intervene.
The deterioration in the technical situation of the four banks had reached the point of no
return. It was no longer possible to delay taking measures to overcome the crisis.
Accordingly, the resolution programme had to begin immediately once the new rules
introduced by national legislation transposing the BRRD had been put in place.
Under this programme, four new entities were created and the business activities were
transferred to them to ensure the continuity of essential services, thus allowing them to
continue banking activities in their geographical areas and to preserve the goodwill value of
the old banks. A vehicle company was then created and the bad debts were transferred to it
with the aim of maximizing their recovery value in the medium term.
The resolution costs were mostly borne by the Italian banking system through the Resolution
Fund and by shareholders and subordinated bond holders. Their sacrifice was proportionate
to the valuation of their assets. The start