Mario Draghi: Overview of economic and financial developments in Italy
Concluding remarks by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the
Financial Stability Board, at the Ordinary Meeting of Shareholders 2009 - 116th Financial
Year, Bank of Italy, Rome, 31 May 2010.
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Ladies and Gentlemen,
The reorganization of the Bank of Italy's branch network to enhance the efficiency of its
essential functions, which was begun in September 2008, proceeded on schedule last year.
A total of 39 of the original 97 branches have ceased operations, and another 25,
specializing in services to users, have been streamlined. In six provinces detached units of
the corresponding regional branches have been instituted to perform banking and financial
supervisory functions. The reorganization is to be completed this year with the specialization
of six branches in cash handling. Permanent savings of some €80 million a year have been
achieved.
The systematic revision of organizational arrangements and operating processes that was
begun in 2007 continued at the central administration as well, last year focusing on banknote
production. The use of more advanced technology and the changeover to simpler
procedures produced gains in efficiency and in the quality of services to the banking system
and to citizens.
In a year of economic and financial crisis and of management and operational challenges to
our organizational structures, the skill and dedication of the staff have been decisive.
The Bank of Italy will contribute to next year's celebration of the 150th anniversary of Italian
unification with two initiatives.
A research project entrusted to Italian and foreign historians, economists, and legal scholars
will examine the ability shown by our economy to adapt to changes in the international
environment over the past century and a half.
Next spring we will hold an exhibition on Italian monetary unification - a little known but
crucial aspect of the broader process of national unification.
The evolution of the crisis and international cooperation
Twenty months ago the collapse of Lehman Brothers opened up grim prospects for global
finance and the world economy. The action of monetary authorities and governments staved
off the collapse of confidence among financial operators, savers, investors and consumers.
In the G7 countries as a group, public financial support for the economy exceeded
5 percentage points of GDP in 2009. Real short-term interest rates turned negative and the
central banks provided unprecedented volumes of liquidity.
Output declined by 2.4 per cent in the United States, 4.1 per cent in the euro area, and 5 per
cent in Italy; GDP continued to expand in the emerging economies, although slowing to
growth of 2.4 per cent.
This year the leading international institutions predict that world output will grow by more than
4 per cent. However, this is the average of widely disparate rates: high in the emerging
economies, above all China; substantial in the United States and Japan; and weak in
Europe, where output is still well below the pre-crisis level.
Government budget deficits and public debt have spiralled. Relief at having avoided
catastrophe has given way on international financial markets to apprehension about the
sustainability of growing sovereign debt. Sales target the government securities of countries
with large budget deficits and high levels of public debt, in particular those that combine
these two characteristics with weak economic growth. The weaker this growth, the more
exacting and pressing are the demands by international investors for a rapid adjustment of
imbalances in the public finances.
These countries have no alternative but to map out promptly a path to restoring budgetary
equilibrium, with a reallocation of current expenditure and with structural reforms aimed at
raising potential output and competitiveness.
These are difficult courses of action and unless coordinated at international level they risk
extinguishing the hesitant recovery. The crisis has attenuated, not eliminated, the worrying
geographical imbalances in world demand. The curbing of debt and increase in saving in the
United States and some European economies are compressing consumption and
investment; they should be offset, more than is already happening, by stronger expansion in
domestic demand in the countries that have built up large external surpluses. In Pittsburgh
last year the G20 launched an ambitious programme of multilateral surveillance of
macroeconomic and structural policies. It is important that this be translated into concrete
strategies to restore balance and support growth. However, it is probable that the process
will not be rapid; the deficits will need to be financed, requiring sound and transparent
markets.
Lessons from the crisis
The roots of the crisis that has beset the world for nearly three years lie in regulatory and
supervisory deficiencies in the main financial centres. The expansionary monetary policy
conducted by the United States from the end of the 1990s helped to create a financial
environment conducive to the explosion in private debt and the aggravation of global
imbalances; these factors heightened the effects of the crisis and fostered their transmission.
Clear indications derive from this for the future, regarding both the system of financial
regulation and monetary policies.
From the start of the crisis the Financial Stability Board was entrusted by the world's highest
political authorities with responsibility for designing the regulatory framework in which the
financial industry will operate in the years to come. On several occasions I have described
the guidelines that continue to inform this plan; how they draw from the diagnosis of past
weaknesses a model for present and future action; and how the ultimate objective of this
work is to make the system more resistant to crises. Some crises may be prevented, others
will be inevitable; but we can take action to limit their damage and contagion.
The agenda develops in four directions:
(i) draw up general rules for the banks: a more robust capital base, lower financial
leverage and control of liquidity risk are the pillars of this;
(ii) introduce specific provisions for systemic intermediaries designed to reduce the
likelihood of their failing, enable their orderly administration if this should happen,
and prevent contagion;
(iii) reduce the importance of ratings in supervision, while simultaneously increasing the
competition between rating agencies and exercising effective control over the
integrity of their decision-making and the transparency of their evaluations;
(iv) increase the transparency of trading on regulated financial markets; and bring
overthe-counter markets back within a framework of universally accepted rules that
impose standard contracts and the settlement of trades with central counterparties
that are subject to supervision.
The first set of reforms requires the utmost international convergence, otherwise regulatory
arbitrage and market integration will preclude their effectiveness. For the second set it would
be more appropriate to talk of minimum harmonization: all countries should adopt measures
in respect of systemic intermediaries, but it is illusory to imagine that the method and timing
of their implementation will be the same across countries because differences in institutions,
markets, business models and economic history are too great. Only when governments and
regulators can allow the institutions that deserve to fail to do so without causing a
catastrophe such as that following the collapse of Lehman Brothers will they have regained
true independence from the financial services industry.
In the United States an ambitious project to reform the regulation of the financial system is
taking shape; for the aspects bearing most closely on international cooperation it is in line
with the agenda of the FSB, whose work is proceeding according to schedule. However, this
year's appointments will be decisive. The most important deadline is the presentation to the
G20 Summit in Seoul next November of the new rules reforming the Basel II Accord.
The financial industry contends that the regulatory reform could impede the recovery. But the
application of the new rules will be gradual and will not begin until the recovery has gathered
force. The changeover to the new definition of banks' capital will be long enough to render its
effects on banks' market value and on credit negligible during the transition. It is important
that the difficulties of the moment not lead to a loosening of the long-term objectives, which
must be kept firm.
The experience of the crisis also influences the design of monetary policies. Their objective
continues to be price stability, but they must be more prepared to counter developments in
credit and money that can fuel financial disequilibria, even in the absence of immediate
inflationary dangers.
Our analyses, among others, show that in order to attenuate the volatility of credit, financial
asset prices and economic activity it is also necessary to prepare instruments such as
countercyclical variations in banks' capital requirements or in loan-to-value ratios. This is
what is known as macroprudential policy. The central banks must play a role in designing
and implementing it.
In times of severe crisis the balance sheets of financial intermediaries are altered and, with
them, the monetary policy transmission channels. The constraints on the availability of credit,
which are only marginally binding in normal times, become stringent when the markets do
not function in an orderly manner; support for credit has a much greater effect on the
economy than the expansion of the monetary aggregates. Changes in the size and
composition of central banks' balance sheets have proven useful in the efforts to stabilize the
markets. This is what the ECB has done and is doing.
The euro area
Euro-area monetary policy has been strongly expansionary for some time. It has ensured
orderly conditions in the credit system and provided support for the recovery of the economy
in a context of moderate inflation expectations firmly anchored to price stability.
The exceptional liquidity expansion measures averted a systemic crisis; they pushed down
interest rates in the money market and helped to reduce those on loans to firms and
households. In order to extend intermediaries' access to funds, refinancing operations were
conducted at a fixed rate and with full allotment of the amounts requested; the range of
financial assets eligible as collateral was widened; the maturity of operations was lengthened
to twelve months. At the end of last year, the Governing Council of the ECB, while not
renewing some exceptional measures it deemed no longer indispensable, continued to
provide all the liquidity necessary to support the economy and the financial system.
But in the last few months the consequences of the crisis have tested the cohesion of the
euro area. The massive creation of public debt, in a phase in which extraordinary quantities
of bank bonds are falling due on the markets, suddenly increased the risk premium on some
sovereign debtors. For Greece, the question had been posed for some time: the loss of
credibility of the public finances, the magnitude of the budget deficit, the public debt and the
external current account deficit, low growth, and the country's weak industrial structure and
unsustainable wage dynamics were pitching Greece into a fiscal crisis that the country's
authorities were slow to recognize.
Just as in the case of American private debt, political indecision and the absence of crisis
resolution mechanisms aggravated the situation. In the Greek case the difficulty of finding a
European accord on a rescue plan, but also the unavailability of a process permitting orderly
management of the debt crises of sovereign states, amplified the damage and the contagion
and at the same time heightened moral hazard.
What was paralyzing the markets was the prospect that Greece's fiscal crisis might lead,
through a deterioration in the quality of collateral, to a collapse of the country's banking
system, which would no longer have had access to ECB refinancing. In addition, there were
fears for other countries' banks with large exposures to Greek counterparties. The risk was
becoming systemic: interbank liquidity was evaporating, the stock markets were plunging.
The ECB and the national central banks intervened promptly, maintaining the option to
accept lower-rated collateral; reactivating the unlimited supply of liquidity in long-term
refinancing operations; and initiating, with the Securities Markets Programme, purchases of
securities in order to resuscitate markets that had become illiquid. The governments of the
euro-area countries and the European Union, in agreement with the International Monetary
Fund, allocated €110 billion for loans to Greece and prepared a mechanism able to mobilize
up to €750 billion in financial assistance to euro-area sovereign debtors hit by a liquidity
crisis, with a contribution of the IMF. The beneficiary countries will have to draw up
adjustment programmes which, if approved by the European Council, will be subject to
periodic verification.
In evaluating the exceptional circumstances that justified intervention in the government
securities market, the Governing Council of the ECB considered that the functioning of the
monetary policy transmission mechanism was endangered and the stability of the euro's
financial system at risk. The ECB sterilizes these interventions, which do not finance public
deficits. Its independence is not in question.
These measures will have to be discontinued as quickly as possible, as soon as the markets
spontaneously resume trading of the securities of the countries involved. This will require
rapid, significant and discernable progress in adjusting government budgets and the fully
operational status of the financing mechanism set up by the European Union and the IMF.
But enduring stability of the markets can only come with the resumption of growth, for it must
not be forgotten that this crisis is above all a crisis of competitiveness.
The recent events pose, again and more powerfully, the old problem of European economic
governance.
A strengthening of the Stability and Growth Pact is urgent. The commitment to achieve a
structural budgetary position in balance or in surplus must be made cogent by introducing
sanctions, including political sanctions, for non-compliance; the accuracy of statistical
information, particularly public finance statistics, must be ensured.
Cogent constraints and commitments must also be introduced for structural policies. The
disparities we have been witnessing for some time in actual and potential growth rates and
the seriousness of the imbalances in intra-area trade in goods and services signal
inadequacies and inconsistencies in national policies. Some objectives of public action to
enhance economic growth in the long run, for example those bearing on the labour market
participation of both the young and the old and on competition in the markets for services,
should be accompanied by controls and, in some cases, sanctions.
The Italian economy
In the two years 2008-09 GDP contracted by 6.3 per cent, almost half the entire growth
achieved in the ten preceding years. Households' real income diminished by 3.4 per cent,
their consumption by 2.5 per cent. Exports fell by 22 per cent. Rapidly spreading uncertainty
and the deteriorating outlook for demand led firms to cut investment, causing it to contract by
16 per cent. Wage supplementation rose to 12 per cent of total hours worked in industry at
the end of 2009. Employment decreased by 1.4 per cent, the number of hours worked by
3.7 per cent.
Some 9,400 firms became involved in bankruptcy proceedings in 2009, a quarter more than
in the previous year. The firms hardest hit are the smallest ones, which often depend on
subcontracted work. Those that had embarked on restructuring before the crisis have
withstood its effects better and now have the best prospects. According to the Bank of Italy's
periodic survey, they expect their turnover to increase in 2010 by 3 percentage points more
than that of comparable firms that had not restructured. Industrial firms with 50 or more
employees that had invested in R&D in the three years preceding the crisis expect their
turnover to increase by more than 6 per cent.
Economic policy limited the damage, containing the fall in GDP by an estimated two
percentage points, of which about one point can be attributed to monetary policy, half a point
to the automatic stabilizers built into the budget and the rest to the recomposition of revenue
and expenditure enacted by the Government. The extension of income support programmes
attenuated the immediate costs of the crisis. The increase in the budget deficit was smaller
than in the other main advanced economies, thanks in part to the solidity of the banking
system, which did not need significant public support. In the other G7 economies this
amounted to 3.8 per cent of GDP on average.
At the beginning of this year it was estimated that the Italian economy would return to the,
albeit modest, growth of the ten years preceding the crisis. In the first quarter GDP grew by
0.5 per cent compared with the previous quarter; there was an improvement in the opinions
of firms, especially exporters, regarding the performance of orders and their expectations for
production. Destocking appeared to have come to an end.
The explosion of the Greek crisis could change the outlook. Some European governments
have taken action to reduce their budget deficits.
The Italian Government has reaffirmed the objective of bringing the deficit below the
threshold of 3 per cent of GDP by 2012, confirmed the commitment to achieving budgetary
balance over a longer time horizon, and brought forward the formulation of the adjustment
measures for 2011-12. According to the official estimates, the measures recently approved
by the Council of Ministers will reduce the baseline budget deficit in 2012 by €24.9 billion; the
measures bear on the main items of expenditure and focus on the operating costs of the
public administration. The package is intended to slow the annual growth in primary current
expenditure to below 1 per cent in 2011 and 2012, thereby reducing its ratio to GDP by more
than 2 percentage points. Over the last ten years expenditure expanded at an average
annual rate of 4.6 per cent and rose by nearly 6 percentage points in relation to GDP. Careful
monitoring of the effects of the package will therefore be needed to ensure the objectives are
achieved.
Italy's financial structure has many strong points. Household wealth, net of debt, is nearly
2 times GDP, considering just the financial component, and about 5.5 times GDP, including
real estate. These levels are among the highest in the euro area, while the household debt
ratio is among the lowest and that of firms is below the average. The net external debt
position of the entire economy can be estimated at 15 per cent of GDP, one of the lowest
values in the euro area, except for Germany, which has a large credit position.
The ratio of public debt to GDP declined by 18 percentage points between 1994 and 2007. In
the last two years of recession it increased by 12 points, to stand at 115.8 per cent. In the
new market conditions action had to be taken even though the budgetary tightening
adversely affects the prospects for economic recovery in the short term.
Competitiveness and growth
In the Monetary Union stagnation, unemployment and, in the long run, budgetary strains are
the inevitable consequence of the loss of competitiveness. The consolidation of the public
finances needs to be accompanied by the revival of growth.
In the ten years preceding the crisis hourly productivity rose by 3 per cent in Italy, by 14 per
cent in the euro area. In the same years the economy grew by 15 per cent in Italy, as against
25 per cent in the euro area. Italy's employment rate remains low, 57 per cent in 2009,
7 percentage points less than in the euro area as a whole. The gap is wider for the young
and reaches 12 points for women.
On many other occasions we have addressed the question of structural reforms. The crisis
makes them all the more urgent: the fall in GDP increases the burden of financing the public
administration; the costs imposed by tax evasion and corruption become even more
unsustainable; stagnation destroys human capital, especially among the young.
The management of turnover in the public sector and the cuts in the discretionary
expenditure of government departments recently decided by the Council of Ministers must
provide the opportunity to rethink the scope and structure of government, rationalize
resource allocation and reduce waste and duplication between different entities and levels of
government. A reform plan covering the entire public sector is needed, to accompany the
measures already adopted to raise the productivity of the public administration by evaluating
the performance of managers and the results of individual units.
Fiscal federalism must enhance efficiency in the use of resources. Only a strong budgetary
constraint, together with the necessary taxing power, can make the fiscal cost of each
decision transparent and cost centres accountable. The specification of the standard costs
and financial needs with which central government transfers will be commensurate, with the
necessary solidarity component, will need to refer to best practices. Each entity will have to
balance its budget, net of investment expenditure, as laid down in Article 119 of the
Constitution. The total amount of local investment expenditure must be fixed for a multi-year
period, in accordance with the objectives for general government net borrowing. Continuing
along the lines laid down for the regions with healthcare deficits, the system of constraints
and disincentives for non-compliant entities will need to be strengthened.
But the budgetary rules are not sufficient to guarantee efficient use of resources. Clear and
comparable information is needed on the quality of the services provided by the various
entities so that single administrations can locate the weak points in their own systems,
citizens can evaluate the performance of administrators, and the State can apply sanctions,
including the power to take over the management of entities that fail to guarantee essential
service levels. Costs and results vary enormously between entities providing the same
services; this indicates that there is substantial scope for improvement. But today we are
beginning to get the data needed for evaluation and concrete action.
A number of initiatives are moving in this direction. The Ministry of Health has drawn up an
experimental set of indicators for healthcare quality, efficiency and appropriateness, both at
regional level and for individual hospitals or health units. The Ministry of Education has
introduced standardized tests into student evaluations to increase the comparability of the
marks awarded and their weight in evaluating teaching effectiveness. The High Council of
the Judiciary has identified a methodology to define standard workloads for judges as a tool
for assessing their productivity.
Tax evasion is a brake on growth because it imposes higher taxes on those who do pay; it
reduces the resources for social policies and obstructs interventions in favour of low-income
persons. The tax wedge on labour is about 5 points higher than the average for the other
euro-area countries; the tax rate on low labour incomes and the corporate tax rate, including
the regional tax on productive activities, are 6 points higher. Istat estimates that the shadow
economy amounts to 16 per cent of GDP. Comparing national accounts data with tax returns,
it can be estimated that between 2005 and 2008 30 per cent of the VAT tax base was
evaded: in terms of tax receipts, this is more than €30 billion a year, 2 points of GDP.
The Government has introduced measures to combat tax evasion. The immediate objective
is to contain the deficit, but in the medium term the reduction of evasion must be a lever for
growth by allowing tax rates to be lowered; the connection between the two must be made
visible to taxpayers.
Corrupt dealing between private agents and general government, in some cases encouraged
by organized crime, is widespread. In the international rankings that are compiled
periodically, Italy stands further and further down on the list. Empirical studies show that
corruption impedes economic growth. There is a close connection between the density of
organized crime and the level of development: in the three regions in the South where 75 per
cent of Italy's organized crime is concentrated, per capita value added in the private sector is
only 45 per cent of that in the Centre and North.
Action to prevent and combat money laundering continues. The Financial Intelligence Unit
and the Bank's Supervision Departments have intensified cooperation with the judicial
authorities and the law enforcement forces, especially in cases where there is a close
connection with criminal investigations.
The crisis has exacerbated the difficulties of young people in the labour market. In the
20-34 age group, the unemployment rate reached 13 per cent on average in 2009. The fall
in the employment rate of younger workers with respect to 2008 was almost seven times that
of their older counterparts. This was due both to the more widespread use of fixed-term
contracts for young people and to a contraction of 20 per cent in new hiring. For some time
now, the gap in employment conditions between the new generations and their predecessors
has been widening to the disadvantage of the former. Entry-level wages have stagnated for
fifteen years in real terms.
A slow recovery increases the likelihood of persistent unemployment. This condition,
particularly at the start of one's working life, tends to be linked to permanently lower earnings
later on.
The reform of the labour market must be completed, overcoming segmentation and
stimulating participation.
Young people alone cannot cope with the growing burden of an ageing population. Nor will
the contribution of foreign workers suffice. Only 36 per cent of Italians aged between 55 and
64 are in employment, against a European average of 46 per cent, and 56 per cent in
Germany.
In Italy in the last thirty years, against a lengthening of more than five years in life expectancy
at age 60, the average age at retirement in the private sector is estimated to have risen by
about two years to around 61. Working life will have to be extended, partly to guarantee an
adequate standard of living to the older people of tomorrow. The countries in Europe with the
highest employment rate in the 55-64 age group are also those with the highest youth
employment.
In 2009 the Government took an important step by automatically establishing a link, from
2015, between the minimum retirement age and changes in life expectancy; a regulation now
being drafted will implement this provision. Actions on the so-called retirement "windows" and
on regulations for women employed in the public sector move in the same direction. INPS
has launched initiatives to give better information to workers about their personal pension
position. The process of pension system reform could be completed by measures that
gradually standardize the retirement age among different groups of workers, speed up
adjustments to the transformation coefficients of the contributions-based system, and provide
greater retirement flexibility.
Banks, supervision
Lending to firms declined by 3.7 per cent on an annual basis between September and
December 2009. In 2010 the pace of the contraction eased and in the three months ending in
April came to 1 per cent. The sharpest decline has been in northern Italy, where industrial
activity is most intensive; lending to firms in the South has begun to grow again. Credit to
households has continued to expand, albeit slowly.
Last year's credit contraction largely reflected the weakness of demand for loans, but there
were also supply-side tensions. According to the Eurosystem's Bank Lending Survey, these
gradually eased from mid-2009 onwards. We recently conducted the survey at regional level,
expanding the sample; the results indicate improving supply conditions in the early months of
this year in the North-West and the South.
In Italy, as in other countries, the quality of bank loans deteriorates during recession. In 2009
the loan losses of our five largest banking groups absorbed almost 70 per cent of their
operating results; their profits fell by over a fifth. The trend, though moderating in early 2010,
has continued and is affecting smaller lenders too, who were less badly hit in the early
stages of the crisis.
With the onset of the Greek crisis, acute liquidity strains in the interbank market have
returned after subsiding last year. Transactions are mostly very short term. There is a large
share of collateralized contracts, a tendency to deal with domestic counterparties and
frequent recourse to bilateral trades. Banks must be prepared to face recurrent and
protracted periods of abnormal market conditions.
As more and more public and private issuers have turned to the markets, in 2011 a flurry of
bank bonds are due to mature for very large amounts; banks must continue to strengthen
their sources of fund-raising, including by making greater use of covered bonds.
Although 2009 was a year of reduced profits, Italian banks made encouraging progress in
strengthening their capital base. Contributions came from market issues, asset divestments,
dividend restraint, and injections of public capital. By March of this year the core tier 1 ratio of
the five largest Italian banking groups had risen to 7.6 per cent, from 5.8 per cent at the end
of 2008.
Our stress tests show that even under adverse scenarios in line with those used in
comparable international exercises, such as GDP growth 3 points lower than current
estimates in 2010-11, compliance with the minimum regulatory requirements and financial
stability would not be at risk in Italy.
However, in the face of persistent market volatility and uncertainty over the macroeconomic
outlook, capital strengthening must continue.
Preparations for the new international standards must be made. The analysis of the overall
effects that the new capital and liquidity rules will have on Italian banks is still under way. The
parameters must be defined; the specific regulatory provisions will be applied flexibly and
with a calendar permitting a smooth and gradual transition. Capital instruments already
issued based on the old rules will continue to count towards the requirement for a long time
(grandfathering).
Supervisory action in Italy has several distinctive features. It does not stop at establishing
general prudential principles, leaving their interpretation up to the market. Nor does it limit
itself to verifying compliance with the rules. Instead, it weighs intermediaries' strategies and
management; without interfering in business decisions, it verifies that governance,
organization, operating processes and control systems are consistent with the risks.
Our off-site controls are supplemented by a high level of on-site supervision. In 2009 there
were over 200 inspections of banks and other intermediaries. Targeted checks increased
substantially. In the largest banking groups the presence of inspectors is continuous and, in
cooperation with the other European authorities, is being extended to their cross-border
operations.
This system of controls, together with particularly prudent regulations, proved vital in
preserving banks' stability during the crisis.
The role of foundations as shareholders in banks cannot be other than that established by
law: investors whose sole objective resides in the economic value of the investment. The
foundations, in their autonomy, will be the first to safeguard the independence of
management.
Major banks are also judged by how they are organized locally: maintaining and capitalizing
on relations with the local economy means basing customer assessments on knowledge
accumulated over the years, which is much more reliable than that inferable from quantitative
models; it means knowing how to discern a creditworthy firm even when the data are not in
its favour; it means knowing your business as a banker. The response of large banks to local
needs, consistent with sound and prudent man