Ignazio Visco: The Italian economy and banks - implications of the
pandemic and outlook
Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the Italian Banking Association
Executive Committee Meeting, Rome, 16 September 2020.
* * *
The current situation and the economic policy response
The repercussions of the acute global crisis sparked by the spread of COVID-19 are still very
difficult to evaluate. The significance of this event, which is without precedent in recent history, is
apparent in the toll it continues to take on human life, social interactions, and the economy.
Uncertainty about the outlook impacts negatively on the spending decisions of households and
firms. Notwithstanding the recent, fragile, trend towards improvement, confidence remains very
low both in Italy and abroad.
In the early months of this year, higher saving rates in Italy reflected difficulties in procuring goods
and services following the suspension of non-essential activities, while the supply of many
products was limited; from the second quarter onwards, saving was mostly driven by
precautionary motives. In the first two quarters, the steep decline in consumption, investment
and foreign demand determined a cumulative drop of more than 17 per cent of GDP, pushing
growth back to the levels of the early 1990s. As was expected, this appears to have been
followed by a significant recovery in production.
Overall, also thanks to the monetary and fiscal measures to stimulate demand, this quarter's
improvement in economic activity could be slightly stronger than the baseline scenario outlined in
our July projections. For now, the trends we are seeing remain broadly consistent with the result
for the year envisaged in that scenario: a drop of just under 10 per cent in GDP followed by a very
gradual recovery.
Considerable risks continue to weigh on the prospects for growth, requiring clarity on the
direction of policies, also over the medium term. The evolution of the pandemic at global level is
not as many had hoped. If protracted, high precautionary savings, which are also widespread in
other advanced economies, can hold back the global recovery in the coming months and risk
becoming rooted in the behaviour of households and firms. Our surveys show that so far the
propensity to cut back on discretionary expenses, such as on travel, vacations, restaurants,
cinema and theatre, concerns not only the least well- off households, but also a large share of
those that have not suffered any significant loss
of income and do not expect to do so in the future either. Another source of uncertainty at
international level concerns the ability of borrowers, and of firms especially, to resume regular
payments once the measures introduced to support them in many countries have been
discontinued. This underscores the need for structural interventions to support the recovery of
the global economy and the solidity of firms with growth potential.
Notwithstanding the gradual recovery from the lows recorded in March, in the first half of
September short-term inflation expectations in the euro area implied by financial asset prices
were barely positive; long-term expectations were just above 1 per cent. It is necessary,
therefore, to continue to ensure the effective transmission of monetary policy in all the euro-area
countries, combating the risk that the current weak inflation trends push up debts in real terms
and impair, including through this channel, the ability of borrowers to honour them.
Last week the Governing Council of the ECB confirmed that the monetary policy stance will
continue to be highly accommodative for a prolonged period of time and that it stands ready to
adjust all of its measures, as appropriate, to fulfil its mandate. Monetary accommodation pursues
the objective of a progressive return to growth in prices of below, but close to, 2 per cent. To this
end, any factor that could hinder this process must be assessed, taking account of, and
combating, all possible downward pressures: those following worse-than-expected trends in
demand for goods and services and in employment, as well as those due to changes in inflation
expectations or exchange rate developments.
Fiscal policy support at both national and European level remains vital. The measures in support
of households and firms will continue to be crucial for alleviating liquidity problems, supporting
aggregate demand, mitigating social hardship and combating rising inequalities. To reduce
uncertainty and to lay the foundations for stable and sustained growth of economic activity and
employment, the solutions to address the public health emergency and the necessary
macroeconomic stabilizers must go hand in hand with resolute interventions on infrastructure,
both tangible and intangible. Europe's decision to institute a fund to ensure the well-being of the
new generations marks a historic step forward: the resources of the Next Generation EU
programme can, and must, help transform the economic and social climate, promote the birth
and growth of firms that in turn can help respond effectively to the challenges posed by new
models of consumption, social interaction, and the reorganization of production. All countries
must identify paths of reform to raise the potential for growth, guaranteeing the equity and
sustainability, in the financial sphere but not only, of economic development.
To this end, Italy must look to those projects that the substantial resources unlocked by the
European programmes make possible, not from the perspective of an ordinary budget law, but
focusing instead on interventions that can ensure we recoup the structural lags that have most
impeded, and continue to impede, the resumption of growth and creation of skilled and stable
job opportunities. If we do this, the entire production system could respond in kind; consideration
must also be given to how financial intermediation can support the efforts of households and
firms. I would now like to offer some brief reflections on this.
The role of the banks during and after the pandemic
Banks have responded to the liquidity crisis that the pandemic unleashed on Italian businesses.
Bank lending increased significantly to reach sectors and firms of all sizes, including the smallest
ones. From the beginning of March to the end of July, loans to firms grew by €47 billion, whereas
they had fallen by about €2 billion in the same period in 2019.
As in other European economies, liquidity has been bolstered by comprehensive government
measures, including debt moratoriums and loan guarantees. These have supplemented the
monetary policy measures adopted by the ECB Governing Council, including the application of
more favourable conditions to the third series of targeted longer-term refinancing operations
(TLTRO III).
The debt moratoriums measure was timely, extensive, and efficiently implemented. At the start of
September, applications from households, including those via the 'Gasparrini Fund' and others
agreed by banks on their own initiative, related to total financing of
€300 billion (while there were more than 2.7 million applications). Applications from small and
medium-sized enterprises (SMEs) under the 'Cure Italy' decree (almost 1.3 million), were related
to loans and credit lines for a value of almost €160 billion.
As I have already pointed out, the disbursement of loans guaranteed by the State was initially
slowed by the exceptional volume of applications from firms of all sizes, as well as by the
numerous changes made to the guarantee schemes. Subsequently, procedures and processing
times gradually normalized, also thanks to the liaison work of the task force in which the Bank of
Italy participates, coordinated by the Ministry of Economy and Finance. The uptake of these
instruments today seems exceptionally high. From mid-March to 8 September, the Central
Guarantee Fund received more than a million applications from banks for guarantees on loans to
firms, mostly SMEs, for an overall total of almost €80 billion. In addition, SACE guaranteed a
further €13 billion of loans to larger firms.
Up to now, the expansion of lending has been backed by public guarantees. Given the structure
of our economy, which is predominantly made up of small and medium-sized enterprises, when
growth starts to gather strength banks will have to meet new requests for financing that will no
longer be supported by such guarantees. A broadly positive response can be expected: a
tightening of credit would end up creating problems for banks' own balance sheets, hampering
the necessary strengthening. The risks of an increase in bad loans and 'unlikely-to-pay' positions
posed by this extremely serious recessionary phase will have to be countered with sufficient
financial resources.
A generalized increase in requests to enforce the guarantees could also have repercussions for
the public finances. These can only be absorbed if there is a sustained economic recovery,
fostered by bank loans as well as by the necessary, progressive, return to prudent budgetary
policies. To prevent the uncertainty surrounding firms' ability to honour their debts from affecting
credit supply conditions and holding down growth, the capital-strengthening measures that have
already been introduced must, where possible, be made rapidly operational.
In the first six months of the year, the CET1 ratio increased by almost 1 percentage point, to 14.8
per cent. This was due to the capitalization of undistributed profits from the 2019 financial year, in
line with the supervisory authorities' recommendations, and to the measures adopted by the EU
to anticipate the entry into force of more favourable risk-weighting for certain asset classes and
to mitigate the prudential impact of the new accounting principles (IFRS 9). Banks' profitability
has gone down sharply nevertheless. Although the drop in operating costs, partly linked to the
months of lockdown and the slowing of productive activities, has more than compensated for
the fall in income, value adjustments on loans have increased sharply. Their growth is almost
entirely due to the need to increase the level of coverage of positions that are still performing, but
whose creditworthiness has inevitably deteriorated following the worsening of the
macroeconomic outlook.
Non-performing loans have continued to decrease until now: between last December and June
this year, net of loan loss provisions, they fell from 3.3 to 3.1 per cent of total loans (and from 6.6
to 6.1 per cent gross of provisions). The ratio of new NPLs to total performing loans has
remained stable, at 1.3 per cent. The trend has, however, benefited from the effects of the
government support measures for firms and households, both directly (debt moratoriums and
guarantees) and indirectly (subsidies, contributions and wage supplementation). The loan loss
provisions reflected the indications of the supervisory authorities regarding more flexible
classification of loans covered by public guarantees and a more gradual provisioning of bad
debts.
Still, banks must use this flexibility with care; they should not simply postpone losses that are
highly likely to occur in the future. The available evidence indicates that the increase in loan loss
provisions recorded in the first half of this year is concentrated among larger banks, in the face of
difficulties that instead appear to be widespread. All banks must adopt instruments for the timely
identification of an increase in borrowers' vulnerability, in particular those who have made use of
the moratoriums and for whom there is possibly little information available at the moment.
Despite the weak cyclical conditions, it is important for banks to continue to preserve adequate
levels of capitalization. In this regard, to absorb loan losses, it will likely be necessary to use at
least part of any capital in excess of the minimum requirements. The reduction of the solvency
ratios must be countered by initiatives to contain costs and increase income; a contribution may
come from the disposal of relatively low-earning assets that are marginal with respect to banks'
core business.
In the years to come, it will therefore be fundamental to continue managing NPLs effectively so
that they do not build up in the balance sheets, hindering efforts to strengthen capital and
undermining market and consumer confidence. Significant progress has been made to date:
granular and standardized bad debt data has been collected; specific organizational units
dedicated to debt recovery have been set up; debt reduction plans have been drawn up; and a
market dealing in this type of assets has been launched. Despite the crisis, in the first eight
months of this year, Italian banks succeeded in selling an amount of NPLs that was only slightly
smaller than what had been planned before the outbreak of the pandemic. Considering the
operations that are being finalized,
it is reasonable to expect that the objectives the banks set themselves at the start of the year will
be achieved in full. We must now rise to the challenge of proceeding along these lines, ensuring
full support to the economy while maintaining capital adequacy.
We need to continue to reduce NPLs by building on our past experience, including by
restructuring those exposures classified as 'unlikely-to-pay' in order to increase the likelihood of
their becoming performing loans again. This is all the more necessary for the banks that are not
yet fully aligned with industry best practices. As we have noted on several occasions, it is
important for actions by banks to go hand in hand with interventions to swiftly raise the efficiency
of the civil justice system to the level of the other advanced economies. A more rapid reduction of
staff shortages and a decisive increase in investment in technology in the judiciary, which are
needed in any case, could make an important contribution. Making court procedures shorter
would also considerably reduce the impact on Italian banks of the rules on provisioning deriving
from European legislation and from the albeit flexible expectations of the supervisory authorities.
The regulatory reforms introduced after the global financial crisis and the supervisory action
carried out in the last decade (especially following the sovereign debt crisis), have had an
important impact not only on banks' capital strengthening but also on the volume of NPLs. As a
result, the resilience of Italian banks in the face of adverse shocks has greatly improved. The
scale of the current crisis could nevertheless require extraordinary interventions.
In this context, the debate at European level is starting up again about initiatives to set up or
improve the functioning of intermediaries specialized in managing NPLs, the so-called 'bad
banks' (asset management companies, AMCs). Solutions that also include the possibility of
private investors participating in the capital of these companies should be looked on favourably.
One possibility is the introduction of a harmonized scheme enabling individual States to work
together with domestic companies without being subject to some of the current rules, for
example by not having to automatically activate burden-sharing if loans are sold at their 'true
economic value' and the AMC has sufficient prospects of making a profit. In Italy AMCO
(previously SGA), owned by the Ministry of Economy and Finance, operates, albeit by closely
interacting with the European Commission, as a de facto AMC, carrying out a very important role
in managing this problem in our country.
Crisis management
Supervisory actions and interventions aim at ensuring that intermediaries are able to operate on
the market by responding effectively to loan requests in a context of safe and sound
management. In some cases, however, exiting from the market becomes inevitable. We have
often recalled that banks are businesses and that they can fail; careful and assiduous
supervision can reduce the frequency of crises, but it cannot eliminate them. In such cases, the
supervisory and resolution authorities act to minimize the direct consequences and to prevent
the failure of one intermediary from posing serious risks to financial stability and the economy.
In the seven years following the global financial crisis, over 500 banks failed in the United States.
There were many failures in Europe too. In Italy, liquidation procedures have involved fewer than
30 banks and banking groups since 2010, most of which were those intermediaries hardest hit
by the double-dip recession that struck the Italian economy.
The banking system's role in crisis management, through deposit guarantee schemes, has been
fundamental; it has contributed significantly to minimizing the repercussions for bank customers
and bondholders, and to preserving financial stability. Considerable resources have been made
available by intermediaries. In some cases public support has been necessary; it may be needed
again in the near future, given the uncertainty over the economic outlook and the situation of
some intermediaries which, while generally small, are not negligible when considered as a
whole.
A measure envisaging the possibility of using public resources to make the liquidation procedure
smoother for banks with total assets of under €5 billion is currently being approved by the
European Commission. It would be beneficial not only that the Commission reaches a positive
conclusion very soon, but also that the measure is extended to 2021 and that it receives more
funding, as it currently only has an envelope of €100 million in the public budget.
In Europe, the issue of the orderly management of crises at small and medium- sized
intermediaries, when there is no public interest in starting a resolution procedure (in itself
problematic, given how difficult it would be for these intermediaries to build up the required
buffers), remains unresolved. It is not a question of asking for public bail-outs of banks that
should not remain on the market, but rather of facilitating their orderly exit as far as possible,
thereby minimizing the impact on customers and on the economy. The institutions must move
rapidly on this front too; we stand ready to make our contribution.
I would also recall that the Banking Union has yet to be completed, including the creation of a
backstop to the Single Resolution Fund as part of the crisis management framework. According
to the reform proposal drafted last year that is still under discussion, the European Stability
Mechanism should play this role.
The experience garnered in the field of crisis management in jurisdictions such as the United
States appears useful. A comparison with the US regulatory framework, and especially with the
modus operandi of the Federal Deposit Insurance Corporation, suggests a series of possible
interventions that could reduce the fragmented and rigid nature of the European approach.
Such interventions are closely linked to the regulation and use of the deposit guarantee scheme,
as part of the construction of the 'third pillar' of the Banking Union. Among the measures moving
in this direction are those designed to promote less dispersion of functions among institutions,
the gradual convergence of national liquidation procedures, and the adoption of the 'least cost'
principle as a criterion for guiding choices on how to intervene and as a condition for making
national procedures more uniform.
Challenges and opportunities
The challenges arising from the crisis caused by the pandemic join those that the banks were
already addressing. In the near future, it will be necessary to satisfy the greater capital
requirements connected with the adoption of new rules and the phasing in of those already
decided (the latest reforms agreed upon by the Basel Committee; the steady deduction from
capital of the loan loss provisions made during the initial adoption of IFRS 9; the minimum
requirement for own funds and other liabilities, MREL; and the Single Supervisory Mechanism's
revision of the internal models). These measures have been partly postponed or spread out over
time to avoid procyclical effects during the current phase, but advance preparation is in any case
required; in the long term, the capacity of intermediaries to withstand adverse shocks and
contribute to strengthening the economy will depend on them.
Banks must continue to recoup levels of profitability that allow them to operate on the market
successfully. The low interest rates that will prevail for a long time to come, the obsolete physical
distribution networks, the upgrading of IT structures and increased competition on the part of new
operators and large technological firms will continue to exert great pressure on banks'
profitability, which the recent pandemic has done nothing to alleviate. The growth of FinTech
enables banks and non-banking intermediaries alike to respond to customers' requests
successfully and to their mutual benefit. Of course, this comes with risks that intermediaries
must deal with, not only in terms of IT security, also by interacting with the Bank of Italy.
In order to seize these opportunities, competences and investments are needed that may not be
within the reach of all banks. The challenge is particularly arduous for those (often, but not only,
small banks) that were already weak before the onset of the crisis or that have only recently
begun to recover following serious difficulties, a process that is inevitably made more complex by
the current economic situation. Investment in technology plays a key role, as it makes it possible
to manage risks more effectively, to optimize production processes and to provide new services.
It is also fundamental in reducing costs and ensuring that work is organized more efficiently.
Preliminary data show, for example, how a non-negligible share of the fall in operating costs
recorded in the first half of the year is attributable to the reduction in property maintenance and
workers' commute costs; a sensible, though of course not exclusive, use of smart working and
of remote communications could make some of these savings structural.
In their action, the supervisory authorities do not discriminate between banks based on size, legal
form, specialization, or business model; they are not 'prejudiced' against specific categories of
supervised entities. Their goals in terms of strengthening the system can be achieved in various
ways. Ad hoc studies show, for example, that there is no one business model for making banks
more profitable and solid; what counts, instead, is that they are sustainable and their corporate
structure is appropriate. The Bank of Italy does not want all banks to conform to the prevailing
model; on the contrary, it believes that preserving 'biodiversity' tends to foster the resilience of the
system.
The aggregation of banks is not a goal in itself. However, if carried out based on a solid
business plan, together with the establishment of consortia and agreements,
they are one of the few tools available to banks to enhance efficiency and to make it possible to
operate successfully on the market. As we have noted on several occasions, for many
intermediaries, a combination of size constraints and specialization often hinder their ability to
make the necessary investment in technology, to innovate their products and processes, and to
harness economies of scale and of scope. Economies of scale are especially significant up to a
certain size threshold; in recent years, their importance has grown following regulatory reforms,
which have raised compliance costs, and technological progress, which has obliged banks to
make significant investment, including in IT security.
The reform of the cooperative credit sector aims to combine the opportunities stemming from
greater size with the necessity of supporting the local economy, to reconcile the cooperative
credit model with the need for sufficient capital levels and to operate in conditions of adequate
profitability so as to remain on the market. To be sure, some aspects still need to be clarified with
respect to the operation and conduct of supervisory checks and the resolvability of cooperative
banking groups, owing to the specificity of their structure and business model. These topics are
being examined by the cooperative banks themselves and by the competent authorities.
The comprehensive assessment of the two new cooperative groups, which has begun recently,
is a crucial part of this process. It will complete the reform and provide strong impetus for these
groups to bolster integration of the various components, improve risk management processes,
and make corporate governance more effective. Also drawing on this experience, the system
composed of the remaining less significant institutions, particularly the small popolari banks (of
which about half are now being given priority by the Bank of Italy's supervisory function) must find
internal solutions for their preservation and renewal.
In this respect, it is difficult to agree with positions which, instead of pushing for a strengthening
of intermediaries' institutions, organization and capital, limit themselves to extolling the virtues of
the model based on small local banks, disregarding the fact that its sustainability is today
jeopardized by the economic transformations under way, and not by the will of regulators or
supervisors. Similar considerations apply to those larger banks that have not withstood the
difficulties brought about the crisis, or have overcome them only thanks to the help of the rest of
the banking system or, within the limits imposed by the rules introduced in Europe, the public
sector.
Good corporate governance, regardless of bank size, is a crucial precondition for dealing
effectively and resolutely with the challenges that I have discussed. We have on many occasions
highlighted the negative effects of weaknesses in the governance structure: little debate within
boards of directors and a lack of effective checks and balances for top management; insufficient
experience and professionalism; conflicts of interest; shortcomings in planning mechanisms,
which translate into delays and a short- sighted approach to strategic decision-making; and
weaknesses in the internal control structure, in the absence of adequate resources and skills.
The regulations attach a central role to the composition and quality of the collegial bodies in
charge of management and control and assign clear responsibilities to the
supervisory authorities. The effectiveness of the requirements for serving on banks' top
management must be measured against the objective of ensuring that the skills are diversified
and consistent with the banks' size, complexity, field of activity and risk profile, in a context that
calls for specialized and multidisciplinary knowledge, absolute integrity and rectitude, full
independence of judgment, and sufficient time for the fulfilment of mandates.
The adoption of more detailed and stringent criteria for selecting company officials is of primary
interest to banks and their shareholders, especially those who do not dispose of sufficiently
effective tools to monitor the conduct of top management. The quality of bank governance is one
of the supervisory authority's priorities for this year, and has been the focus of ad hoc studies
that will continue into the future. The forthcoming entry into force of the new requirements
therefore represents an opportunity to strengthen corporate governance, the sound and prudent
management of banks and their competitiveness, in compliance with the general principles of our
legal system and of national specificities. The margins for intervention on the part of the
supervisory authorities will be expanded thanks to the broader set of conditions to be considered
when assessing whether corporate officials are fit to serve.
Stronger balance sheets, adequate profitability and good corporate governance are necessary
not only for the stability of the individual banks and of the system as a whole. They are needed to
protect the savings of depositors and of those who have invested in bank bonds and stocks, as
well as to safeguard those accessing credit. They are, therefore, a prerequisite to meet,
effectively and transparently, the financial needs of the households and firms that turn to banks,
as well as to pursue an efficient allocation of resources. All of this is needed more than ever
today, not only to respond to the impact of the pandemic, but above all to support our economy's
exit from the stagnation in which it has long been mired.
A discussion has also begun, in recent days, about the possibility of the State intervening in the
banking system by acquiring direct ownership of those intermediaries that are trying to complete
difficult restructuring and recovery processes, with a view to creating a 'public- sector banking
hub' that can help support the real economy, especially in the South and for small firms. This is a
complex question. One may debate about the link between the type of ownership and the results
it can achieve when running a company, but past experience of public-sector bank management
has not infrequently revealed serious inefficiencies in the resource allocation processes.
Nor must it be forgotten that the Italian economy would benefit not so much from the support of a
large state-owned bank, but first and foremost from an efficient public administration, adequate
infrastructure, and investment in innovation and knowledge. In any case, it is especially important
to ensure that commercial banks operate as best they can from an organizational and
managerial point of view, responding effectively and transparently to firms' and households'
demand for credit and the allocation of savings. The nature of public- sector development banks
is different and, perhaps, more complex. The benefit of moving in this direction and the ways of
doing so should be weighed carefully.
* * *
Banks' conditions and their ability to provide loans and financial services are inevitably affected
by the performance of the economy. Also for this reason, it is important that action intended to
promote a return to a path of steady, balanced and lasting growth accompany, as soon as
possible, the emergency measures taken to limit the consequences of the crisis brought about
by the pandemic.
From this standpoint, the Next Generation EU programme is an important opportunity that must
not be missed. The benefits that Italy will be able to derive from it will depend on its capacity to
submit measures that are targeted and consistent with the objectives and requirements of the
programme and to implement them rapidly and without inefficiencies. This will also create the
conditions for achieving a gradual and continued rebalancing of the public accounts, thereby
avoiding a situation in which Italy's higher indebtedness ends up exacerbating the country's
problems instead of alleviating them.
For their part, banks must continue with renewed vigour in their institutional, organizational and
capital strengthening. This is an essential condition for successfully meeting the challenges
posed by the changes that have taken place in the markets, in technology and in regulation, and
for tackling the gaps that have accumulated over the years, which have been exacerbated by the
repercussions of the crisis triggered by the pandemic.