Mr. Desario reports on growth prospects and implications for supervision of
Address by the Director General of the Bank of Italy, Dott. Vincenzo Desario,
asset management
at the conference "Asset management: insurance companies versus banks" held in Rome on 9/4/98.
1. Introduction
The growth of asset management has been a common feature of the financial systems
of all the leading industrial countries. In Italy, the growth has been especially rapid in the last two
years, under the influence of both cyclical and structural factors.
The professional management of savings has always been a characteristic aspect of
financial intermediation. Its scope was originally limited to the management of individual estates and
the provision of financial advice.
The mandate to engage in financial investment conferred by savers (asset
management) does not place intermediaries under an obligation to repay the nominal value of the
principal invested, nor does it guarantee the achievement of a given yield. The scope of the activity
has become much broader; it now involves a wide range of different financial intermediaries and
instruments and a much larger pool of investors.
The sharp increase in financial flows has led intermediaries to operate in a variety of
markets and expand the number of innovative products they offer. The ranks of those involved have
grown: banks and insurance companies have been joined by investment houses and investment fund
management companies, the savings of high-income customers by those of lower-income workers
and pensioners, and individual investors by institutional investors.
The operational overlap between different categories of intermediary and the
substitutability of different types of instrument have increased. Competition has become fiercer at
both the domestic and the international level. The need to achieve a critical mass in order to operate
in a market where the geographical boundaries and the supply of products are changing rapidly has
prompted reorganizations, concentrations and the formation of conglomerates.
The expansion of asset management has been a major driving force in financial
innovation and has contributed everywhere to the erosion of institutional segmentation and to the
pressure to change the organization of controls.
I shall look first at the evolution of asset management at the international level, before
analyzing its development in Italy and the role of banks and other intermediaries. In view of the
opportunities and risks that this development entails, I shall also address supervisory issues, the new
legal framework established recently with the consolidated law on financial markets and the need for
closer and more effective cooperation between authorities, both in Italy and in international fora.
2. Asset management in the industrial countries
The rapidity of the growth of the international asset management industry is reflected
in the share of the financial instruments it offers in households' portfolios and the importance of
institutional investors.
Between 1982 and 1994 - a period for which comparable figures are available - there
was a significant shift in the composition of households' portfolios in all the leading OECD
countries: while the share of financial assets held as bank deposits declined, that of products offered
by insurance companies, investment funds and pension funds grew steadily.
Significant differences between countries nonetheless persist within this common
trend. At the end of the period considered, the proportion of households' financial portfolio
consisting of managed assets was one-sixth in Italy and France, one-fourth in Germany and Japan,
two-fifths in the United Kingdom and three-fifths in the United States.
During the same period, the assets of institutional investors (insurance companies,
investment funds and pension funds) increased in relation to the total volume of financial
intermediation and gross domestic product. Differences in the role of institutional investors in the
various countries are captured by the latter indicator: the assets under their management were equal
to 30 per cent of GDP in Italy and Germany but amounted to more than 200 per cent of GDP in the
United Kingdom and Japan (Table 1).
The disparity in the size of the sector in the different countries does not prevent us
from identifying a number of shared structural determinants of the growth in asset management.
The first and most important is the gradual aging of the population, which fuels
demand for pension-related financial instruments. The difficulties faced by public pension systems
reinforce this trend: asset management has grown the most in countries whose pension systems are
primarily based on private pension schemes; where public systems play a major role, the sector has
developed later and grown more slowly.
The tight limits on budget deficits imposed by the stability pact among the countries
participating in the Economic and Monetary Union will accelerate recourse to private pension
arrangements, giving additional impetus to the growth of institutional investors in Italy, France and
Germany.
The liberalization of capital movements at the end of the 1980s was an equally
important propulsive factor. New opportunities to diversify financial investments were opened up to
savers in countries that had previously imposed foreign exchange restrictions. It became possible to
construct portfolios with the desired combination of risk and return; at the same time, it became more
difficult to manage portfolios, increasing the importance of the services offered by specialized
intermediaries.
The decline in the rate of inflation in recent years, together with the restoration of
macroeconomic stability, has been another factor contributing to the growth and has encouraged a
shift in financial resources towards longer-term assets and, above all, the stock market.
The spread of asset management has not had the same features everywhere. In the
United States, the process has been accompanied by a considerable reduction in the role of banks; in
the countries of continental Europe the latter have retained a significant position and in many cases
have been the main actors in promoting the growth of the sector.
In reality, the growth of asset management does not necessarily lead to banking
disintermediation: the competition triggered by the changed preferences of savers, new technology
and more refined financial instruments, and the evolution of the legal framework does not favour any
one type of intermediary but rather modifies the characteristics of financial intermediation and
financial products as we know them today.
Asset management, defined as the all-inclusive professional management of savings,
is destined to produce lasting changes in the structure of the financial system we have inherited, in
three main directions: greater concentration in the production of asset management services, an
expansion of financial assets in relation to real wealth, and an increase in the importance of the
securities market.
The search for optimal size in asset management activities, international
diversification strategies and the need to create efficient integrated structures for the production and
distribution of financial products have given rise to mergers between some of the world's leading
intermediaries.
The growth in asset management has contributed to financial deepening in the leading
industrial countries. Between 1982 and 1994 the ratio of gross financial assets to real wealth rose
from 0.8 to 1.6 in the United States and from 1.5 to 2.5 in the United Kingdom.
Institutional investors are channelling an increasingly large volume of funds towards
the financial markets. The arbitrage activities they engage in and their ability to trade in highly
volatile financial assets give breadth and depth to the securities market, reinforcing its role in the
allocation of savings and the redistribution of risk. It is worth noting the introduction of derivative
credit instruments and the growing recourse to techniques for securitizing of bank loans.
The connection between the development of asset management and the growth of the
stock market is shown by the fact that at the end of 1995 the shareholdings of UK pension funds
were greater than the total capitalization of the Italian and German stock markets.
In certain circumstances the behaviour of institutional investors could accentuate
tensions in securities markets. In markets of insufficient depth, price fluctuations are likely to be
amplified by the use of dynamic hedging techniques or the imitative behaviour of managers seeking
to reduce the risk of performing less well than their competitors.
3. The growth of asset management in Italy
In Italy, the spread of asset management products has increased appreciably in recent
years, approaching the levels achieved in the other leading countries.
Between 1990 and 1997 the aggregate comprising investment funds, portfolio
management services, pension funds and life insurance companies' technical reserves increased from
150 trillion lire to just under 1,000 trillion, rising from 8.5 to 33 per cent of total domestic financial
assets (Table 2).
The increase was especially large in 1997. Net fund-raising by investment funds
tripled by comparison with 1996 and amounted to 143 trillion lire. In the first nine months of 1997,
the net inflow of resources to portfolio management services nearly doubled to 64 trillion lire, while
premiums paid in respect of life insurance policies grew more moderately, increasing by 44 per cent.
The differences between the products offered by the various categories of
intermediary have narrowed. About one-quarter of the funds raised by portfolio management services
were reinvested in investment funds. In the insurance industry there has been strong growth in
products with a more pronounced financial component, such as single premium policies, sales of
which increased by 125 per cent in the first nine months of 1997.
The impressive increase in asset management in 1997 was boosted by the decline in
interest rates that accompanied the fall in inflation. Small investors entrusted professional managers
with savings that had previously been invested in government securities as they sought to increase
their returns, inter alia through capital gains.
The shift from personal investment to asset management has led to a greater
diversification of households' and firms' investment portfolios. Nonetheless, considering the total
assets held directly or indirectly by savers shows that the redistribution of final investment
instruments is taking place gradually. In the past two years the substantial reduction in households'
demand for government securities has been largely offset by the increase in the subscriptions of
investment funds. Only in part has it translated into purchases of listed shares and especially foreign
securities.
The preference for asset management is likely to be reinforced by the recent changes
in the tax treatment of financial assets. The new procedures for the taxation of financial income,
based on an all-inclusive approach, relieves investors in managed asset instruments from having to
send in returns and requires the intermediaries providing the service to settle the related tax
liabilities. The new rules also standardize the procedures for individual and collective instruments; a
simplification that should enhance operational efficiency.
The flow of funds to institutional investors and to the securities market requires an
adequate response in terms of the supply of financial instruments. Greater recourse by firms to the
market, through debt and equity issues, will enable the productive economy to benefit from Italy's
substantial saving capacity and give intermediaries an opportunity to expand their investment
banking services.
The supply policies of banks, especially the leading Italian banking groups, have
played a key role. Capitalizing on professional asset management is now a central strategic objective;
it is in line with customer preferences, helps offset the downward trend in interest income, increases
productivity through a better utilization of labour, and consolidates the fiduciary relationship with
savers.
In 1996 managed asset services contributed substantially to banking groups'
profitability, producing gross revenue of more than 4 trillion lire or around one-third of pre-tax
profit.
In the same year banks and their subsidiaries handled 70.4 per cent of all managed
assets in Italy, up from 63 per cent in 1992. Considering investment funds and portfolio management
services only, at the end of 1997 the volume of assets managed directly or indirectly by banks
amounted to four-fifths of the total. Banking groups have strengthened their central role in asset
management; overall, there has been no significant impact on the volume of funds intermediated by
the credit system.
Over the past five years the fund-raising policies of the bank-controlled asset
management companies have transformed the rankings in this sector; the number of bank-controlled
companies in the top five has risen from two to four.
Marketing capabilities and the fiduciary relationship with customers have given
banks a competitive edge over other financial intermediaries. The expansion of the distribution
network in years past through the progressive diversification of channels (branches, financial
salesmen, marketing agreements) has produced very extensive coverage of the territory.
A survey of the banking system conducted by the Bank of Italy found that at the end
of 1995 portfolio management services were offered by more than 60 per cent of all banks, life
insurance products by over 70 per cent, and investment fund units by 80 per cent.
Insurance products are increasingly simple and standardized, which has facilitated
their marketing via bank networks and financial salesmen. In the first nine months of 1997 the share
of life insurance products sold through bank networks was 33 per cent, compared with 25 per cent in
the same period of 1996; the share marketed through agents dropped from 42 to 36 per cent.
4. Banks and other intermediaries: competition and integration
The Italian financial system was historically bank-oriented rather than
market-oriented. It did not offer valid opportunities for portfolio diversification: the scope for
investment was restricted to one instrument - bank deposits - offering modest yields and a nominal
value that was stable over time.
In the last fifteen years Italians' high propensity to save, the increasing supply of
government securities, the launch of investment funds and the liberalization of capital movements
have enormously enlarged the role of the financial markets and the opportunities for diversification.
There nonetheless remain risks for the economy as a whole that the markets do not
help to control and which financial theory defines as "non-diversifiable". Such risks are connected
with the economic cycle or the alternation of periods of financial euphoria and panic, which tend to
generate broad swings in asset prices and thus affect households' wealth. In such circumstances, an
important role is played by intermediaries that perform the function of converting risk via their
balance sheets through the supply of such non-negotiable instruments as bank deposits and
defined-benefit life insurance products.
Financial innovation continuously redefines the interaction between markets and
intermediaries. It is this process that determines the ability of the financial system to sustain the
growth of the economy and offer instruments with adequate safeguards for households' and firms'
savings.
The growing competition between instruments, types of intermediary, and
intermediaries and markets thus does not eliminate some of the features that distinguish the
operations of banks, insurance companies and securities intermediaries.
Banks necessarily have a large portion of their assets tied up in non-negotiable
assets - loans. They retain a central role in the provision of payment services. They are the main
channel for the transmission of monetary policy impulses, owing to the convertibility of deposits into
legal tender.
Insurance companies are characterized by the production of non-negotiable
instruments that offer customers a guaranteed return even for the long term.
Securities intermediaries are geared to efficient trading in securities. The liabilities
they issue do not carry the obligation of redemption at face value and are not means of payment.
The intensification of competition is a force for the increasing integration of
specialized intermediaries within group structures.
The reasons for integration are often to be found precisely in the field of asset
management, where the overlapping between banking, insurance and securities business is most
pronounced.
Competition spurs the drive for ever greater size, permitting adequate diversification
and the exploitation of economies of scale in the supply of individual and collective asset
management services. The recent wave of mergers among the leading global intermediaries confirms
the link between the enlargement of the market, the increase in competition and the effort to achieve
critical mass. For instance, the merger between Union Bank of Switzerland and Swiss Bank
Corporation, already the third and fifth-largest European banking groups at the end of 1996, created
an intermediary with some $680 billion of managed assets, nearly three times the total net assets of
Italian investment funds.
Competition and concentration are bound to intensify with economic and monetary
union, which will eliminate the residual segmentations based on the currency of denomination of
financial products.
In the drive for efficiency, Italian intermediaries have also begun to centralize
functions that were once performed by different operational units and not always integrated in
operational or administrative terms. They are rationalizing the production and distribution of their
different asset management services within group structures, but they have not yet attained the size
needed in order to compete at the European level.
Italian intermediaries can defend their position in the domestic market effectively,
capitalizing on their customer relations and distribution capabilities. With respect to certain groups of
investors, however, such as firms, foundations and wealthy individuals, the distribution network is of
minor importance, and foreign intermediaries are likely to be increasingly effective competitors.
Over the longer run, the spread of electronic sales networks and other marketing innovations will
intensify competition in standardized products for the retail market as well.
The acceleration of mergers and takeovers within the Italian banking industry and the
growing recourse to forms of integration between credit and insurance institutions reflect the
commitment to enhance the competitiveness of the financial system and to reposition the sector
within the European market.
Alongside the major intermediaries there is still room for local operators, but their
success requires highly specialized production strategies, aimed at particular instruments and
markets. Alternatively, these banks could concentrate on strengthening their distribution capabilities,
perhaps through agreements with large-scale asset management institutions that do business in a
number of different financial market centres, in order to obtain more sophisticated products and offer
their customers a broader range of services.
5. The new regulation of asset management
The erosion of the geographical and product barriers between markets, the creation of
complex and internationally ramified groups, the increasing competition between different types of
intermediaries and the growth of securities markets have enhanced the investment opportunities
available to vast numbers of small investors; they have also called for a major effort to adapt the
regulatory framework and the organization of supervision in order to protect the savings invested and
the stability of intermediaries.
The revision of the regulations governing the various financial sectors, partly in
response to the process of harmonization within the European Community, has eliminated the
competitive inequalities between different intermediaries operating in the same markets, created
instruments for exercising control in order to counter the risks arising from the new forms of
organization of financial activity.
In Italy, the Consolidated Law on Financial Markets has responded to the problems
posed by the new and diversified structure of supply by thoroughly overhauling the rules governing
financial intermediaries and markets.
The statutory innovations will allow Italian intermediaries to diversify and broaden
the range of services they provide, adopt more flexible organizational structures and compete on an
equal footing with foreign firms.
The earlier legal framework restricted the scope for innovation, especially in the field
of collective investment, where new types of investment funds could only be introduced by primary
legislation.
The extensive recourse made to secondary instead of primary legislation has removed
the constraints on the diversification of products and services. In particular, the Ministry of Treasury
is charged with the task of defining the principal characteristics of the various types of investment
funds, with special reference to eligible assets (listed securities, unlisted securities, real estate, etc.),
whether the fund is open or closed-end, and the nature of potential customers (small savers or
institutional investors).
The Bank of Italy is charged with regulating the management of investment funds'
portfolios. In addition to the earlier tasks associated with the prudential supervision of undertakings
for collective investment in transferable securities (UCITS), it is now responsible for establishing the
procedures and prohibitions for investment activity and for the limitation and diversification of risk.
The most important innovation is the elimination of the separation between
management on an individual basis and that on a collective basis with the creation of a single
manager, the "asset management company".
Investment firms, banks and trust companies continue to be allowed to provide
individual management services directly, while asset management companies are allowed to provide
both individual and collective management services on an exclusive basis. The possibility of
operating across the board will enable them to achieve higher levels of productive efficiency.
The right to provide the two services jointly, which is consistent with the proposed
Community directive currently under discussion on the collective management of assets, meets the
needs of intermediaries and puts them in a better position to satisfy the preferences of their
customers. At the same time, the prohibition on the supply of other services is an important defence
against conflicts of interest.
Major changes in the direction of greater flexibility have also been introduced at the
organizational level. In particular: the management and promotion of funds may be separated and
entrusted to different companies; managers may delegate investment activity within a set of criteria
for the allocation of resources; and in the field of individual management services banks and
investment firms may entrust the execution of management contracts to third parties, for part of the
portfolio or even the entire portfolio, subject to written authorization by the customer. The granting
of considerable autonomy in the organization of production reflects the belief that the supply of
management services is a complex business with high fixed costs and large economies of scale.
The importance of group structures in the financial industry and the related need to
strengthen prudential controls suggested extending the scope of the rules on consolidated supervision
to financial groups having at least one investment firm or asset management company.
Responsibility for issuing the regulations lies primarily with the Bank of Italy, which is required to
define such groups for supervisory purposes and draw up the prudential rules to be applied on a
consolidated basis.
The division of supervisory responsibilities according to purpose has been confirmed
and further clarified for all intermediaries. Consob is entrusted with ensuring the transparency,
correctness and regularity of trading, while the Bank of Italy is responsible for the controls aimed at
protecting investors and ensuring the capital adequacy and stability of intermediaries.
Faced with the continuous and at times tumultuous development of financial markets,
the debate on the optimal organization of supervisory controls sometimes appears to be conducted at
an excessively abstract level. The experience of recent years shows that supervisory arrangements
must be constantly adapted to the situations created by financial and technological innovation.
The transfer of vast sums to the care of professional managers by small savers
belonging to a wide range of social groups raises special issues with regard to financial stability.
Naturally, there is no derogation from the principle that the result of delegated investment depends
on the performance of the management scheme, which may involve both lower-than-expected rates
of return and capital losses. Managers nonetheless have a special responsibility to safeguard the
value of such savings. It is indispensable that management choices should correspond to the risk
profiles accepted by investors and, more generally, that the rules on risk diversification should be
observed. The prudential limits on operations established and monitored by the authorities become of
great importance.
The structural changes under way in the Italian financial system require the different
supervisory regulators to intensify their coordination efforts. Effective cooperation among authorities
enhances the effectiveness of controls, and the ability to forestall instability is the key to achieving
the efficiency gains that the growth of financial markets makes possible.
The consolidated law imposes an obligation on the authorities to collaborate,
inter alia by exchanging information; they cannot invoke official secrecy in their dealings with each
other. The importance of coordination is thus confirmed, in recognition of the dangers that inefficient
cooperation is likely to entail for the integrity and efficiency of the financial system. At the same
time collaboration must be informed by the principle of minimizing the costs borne by those subject
to supervision.
The globalization and increasing competition between financial centres that have
accompanied the growth in asset management have also spurred a far-reaching reorganization of the
securities markets. The consolidated law completes the innovations introduced by Legislative Decree
415/1996, which provided for the privatization of the stock exchange and the securities markets. The
management of the markets is entrusted to limited companies that have private sector shareholders
and self-regulatory powers in matters such as the admission of financial instruments and
intermediaries to the market, as well as their exclusion and suspension.
Consob is charged with the supervision of the regulated markets; the Bank of Italy
has been given a primary role for the markets that are important for monetary policy purposes: the
screen-based government securities market (MTS) and the interbank deposit market (MID).
6. International coordination
The response to the growing integration of markets has been to complete the reform
of financial regulations, with the creation of a system of controls that is basically neutral with respect
to the nature of intermediaries and based on cooperation among supervisory authorities.
The internationalization of finance results in cooperation among the authorities of
different countries becoming of fundamental importance. The increasing openness of financial
markets makes the exchange of information indispensable, requires a flexible interpretation of
cooperation agreements and calls for the coordination of corrective measures. The links between
supervisory bodies must be permanent, not restricted to crisis situations, and must involve both the
authorities responsible for controlling intermediaries and those with powers over markets.
The growth of asset management, where the activities typical of institutions engaged
in banking, insurance and securities investment services intersect, has fostered the rise of financial
conglomerates.
The presence of these complex organizations creates new channels for the spread of
possible crises; their international ramification and the existence of different types of intermediaries
increase the difficulty of coordinating the supervisory bodies involved.
Generally speaking, the emergence of a small group of very large global operators
with substantial capital and highly diversified portfolios strengthens the financial system; the
emergence of such a group nonetheless faces the international community with the problem of
forestalling the possibility of an insolvency and defining instruments on an adequate scale for
handling such an event.
The supervision of financial conglomerates is hindered by the existence of
unregulated entities, but problems also arise where all the components are subject to prudential
controls. In the case of capital adequacy, it is necessary to avoid double and multiple gearing, which
can result in the group as a whole failing to have adequate capital even though the individual units all
satisfy their respective capital requirements.
The ramification and strategies of groups can reduce the effectiveness of individual
supervisory authorities' prudential controls and make it less easy to overcome company crises.
Risk control in the more complex financial conglomerates is often centralized in a
single operating unit; the correspondence between company structures and lines of business ceases to
exist; group activities are no longer covered by supervisory controls, which are divided by country,
type of institution and product. Regulators are likely to encounter greater obstacles to the effective
performance of their tasks because functions that are crucial to the sound and prudent management of
the undertaking subject to supervision are carried on in a different jurisdiction.
Awareness of these difficulties has led to an intensification of cooperative efforts in
international fora. At the beginning of 1996 the Basle Committee on Banking Supervision, the
International Organization of Securities Commissions (IOSCO) and the International Association of
Insurance Supervisors (IAIS) set up the Joint Forum on financial conglomerates and charged it with
the task of addressing the supervisory issues raised by these complex financial organizations.
In particular, the Joint Forum has studied the practical means of facilitating the
exchange of information among supervisory authorities, at both the national and the international
levels, and has examined arrangements for facilitating the coordination of control activities both in
ordinary circumstances and in crises. It has also drawn up a list of principles aimed at permitting
more effective supervision of regulated institutions within financial conglomerates.
The proposals put forward by the Joint Forum primarily concern the methods for
evaluating the capital adequacy of conglomerates and verifying the integrity and experience
requirements for corporate officers and significant shareholders. Common reporting formats have
been prepared for use by authorities in order to improve their understanding and analysis of the
structure and operations of conglomerates.
The possibility has been examined of identifying one authority to act as coordinator
with the aim of facilitating the exchange of information, permitting an overall assessment to be made
of the riskiness and capital adequacy of groups, and improving the consistency of prudential controls
and the timeliness of corrective measures. This hypothesis nonetheless requires that consideration be
given not only to the benefits just mentioned but also to the danger that supervisory action will be
made more complex and the safety net seen as having been extended to all the components of
conglomerates, including those that are unregulated.
As things stand today, coordination among supervisors has to rely on their practice of
exchanging information, the knowledge each