Ignazio Visco: 2013 World Savings Day
Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the 89th World Savings Day,
organised by the Association of Italian Savings Banks (ACRI), Rome, 30 October 2013.
* * *
After a prolonged decline, in Italy there has been a slight recovery in saving in the last two
years, from under 17 per cent of national income in 2010 to almost 18 per cent in 2012. The
increase reflects a reduction in the negative contribution of the public sector. Private sector
saving has continued to fall, but more slowly.
With the continuation of the recession Italian households, which initially had buffered its
impact on their spending behaviour by reducing their saving, revised their spending plans
downwards, adjusting them to lower permanent income. A factor was the acute uncertainty
over the valuation of wealth, in turn linked to the prolonged strains in the financial and
realestate markets. In 2012 consumption fell sharply, in line with disposable income, and it
remains weak, notwithstanding the first signs of improvement in households' purchasing
power.
In the first half of 2013 GDP continued to decline, albeit at a more moderate pace. In the
context of a euro-area recovery that is both slow and uneven, the latest indicators for Italy
are consistent with GDP stabilizing in the third quarter and returning to modest growth in the
fourth. Uncertainty remains high. In the summer the contraction in industrial production
eased. About half of the firms surveyed by the Bank of Italy reported that the worst of the
crisis had passed; smaller firms and those exporting less are still in greater difficulty.
The trend in capital formation also seems to be turning round. In the second quarter
purchases of machinery and equipment recorded their first increase in more than two years.
The prolonged decline in construction is slowing. An acceleration of investment in the
remaining part of this year and next year is indispensable for renewed economic growth.
Savings must flow to businesses through a revival of bank lending but also through greater
direct access to the capital markets to reduce firms' dependence on the banks. This means
overcoming a structural lag of our financial system, manifested in the small number of listed
companies and the limited level of stock market capitalization in relation to the size of the
real economy.
Business loans have decreased by almost 8 per cent (more than €70 billion) since the end of
2011 when the first, sharp contraction occurred. As a proportion of GDP they have fallen
from more than 59 per cent in November 2011 to about 55 per cent in September 2013. The
unfavourable macroeconomic conditions continue to restrain credit demand and supply; loan
supply is affected by the increase in firms' credit risk and the related adverse selection
effects.
Italian firms' financial leverage is high by international standards: in 2012 the ratio of financial
debt to the sum of that debt and shareholders' equity at market prices was 49 per cent in
Italy against 34 per cent in France and the United States, 39 per cent in Germany and 42 per
cent in the United Kingdom and in the euro area as a whole. Analyses of firms' financial
statements indicate that these differences are due only in part to dissimilarities in sectoral
and size composition. Italian households invest only a small amount in listed shares (2 per
cent of their total financial assets, against 4 per cent in Germany and on average in the euro
area). Only a small proportion of Italian investment funds invest widely in shares.
The current financial situation should spur banks and firms to overcome this state of affairs.
Difficult credit conditions necessitate recourse to alternative channels of funding for sound
businesses with good growth prospects. By providing the necessary services to accompany
these businesses on the capital markets, the banks can sustain their own earnings and at the
same time reduce their risks, although conflicts of interest must be avoided.
Inflows of foreign capital could help to improve firms' funding conditions. After the substantial
outflow between the summer of 2011 and the first four months of 2012, foreign portfolio
investment is picking up; the easing of financial tensions, assisted by the unconventional
monetary policy measures taken by the Eurosystem, has contributed to this. The
maintenance of balanced public finances and the continuation of reform actions to support
growth - accompanied by progress towards the completion of the European Union - can
improve confidence and reduce the perception of investment risks in our country, allowing us
to consolidate the recovery of capital flows from abroad.
The Italian banking system
Italian banks have weathered the global financial crisis, a double-dip recession, and the
sovereign debt tensions. The capital strengthening carried out in the course of the last,
difficult years has been substantial; in Italy, unlike other countries, it was achieved virtually
without recourse to public funds. For the system as a whole, between the end of 2007 and
June 2013 core tier 1 capital increased by €39 billion, to almost €180 billion. The core tier 1
ratio accordingly rose from 7.1 to 10.9 per cent; for the top five banking groups it reached
11.2 per cent, in line with the average for the main European banks.
Banks' liquidity position benefited from the Eurosystem's three-year refinancing operations,
which enabled them to offset the fall in international funding owing to the sovereign debt
crisis and to build up bond redemption reserves. The increase in banks' exposure to Italian
government securities - from €220 billion at the end of 2011 to €415 billion in June 2013 -
reflected the economic advantage and necessity of temporarily investing the liquidity
obtained from the Eurosystem in a setting of increased riskiness of lending. In the third
quarter this exposure decreased by almost €10 billion. With the economic recovery and the
attendant improvement in firms' prospects, it is likely that banks will review their fund
allocation policies.
Aside from government securities, assets eligible as collateral in refinancing operations
include own-use government-guaranteed bank bonds that will mature over the next few
years and, in any case, as of 1 March 2015 can no longer be pledged directly by the issuer.
Sufficient collateral must be maintained to replace the assets that are no longer eligible, in
order to make up for any falls in value.
The Bank of Italy is currently developing new ways of facilitating the use of certain types of
loan that are especially widespread in our country, such as current account credit lines; some
contractual changes will be required to ensure consistency with the ECB standards. The
procedures for accepting loan portfolios are also being defined. The adoption of the Bank of
Italy's internal assessment model, authorized last July by the ECB, will enable small banks in
particular to avoid penalizations in terms of valuation haircuts.
Efforts to regain full access to the international markets must continue. Massive recourse to
central bank liquidity cannot be a permanent mode of funding for banks.
The view that Italy's banking system stands in dire need of recapitalization is unfounded.
Only recently the International Monetary Fund published the results of its latest Financial
Sector Assessment for Italy. I have already had occasion to point out that the IMF's stress
tests, and similar exercises conducted by the Bank of Italy, show that the system can
withstand not only the macroeconomic weakness posited in the baseline scenario for
2013-15 but also a less favourable scenario in which GDP growth is cumulatively more than
4 percentage points lower in the same three years. In this case, the additional capital
required by some intermediaries in order to meet the minimum regulatory requirements
would be limited; depending on the definitions used, it would amount to between €6 billion
and €14 billion. These are - it is worth emphasizing - hypothetical capital needs that would
arise only in an improbable scenario.
The Financial Sector Assessment Program's findings dovetail with the analyses that the IMF
itself has conducted at aggregate level in its recent Global Financial Stability Report, which
estimates the losses on loans to firms that the Italian banking system could face in an
adverse economic scenario at €125 billion for the two years 2014-15. Considering the
writedowns already taken, this amount is reduced to €53 billion, less than the gross profits banks
are expected to make in the same two years. The losses, therefore, should not affect the
system's total capital.
Italian banks have been protected first and foremost by business models that remain rooted
in traditional retail banking business. In part thanks to the attentive supervision of the Bank of
Italy, the system avoided the kind of massive investments in "toxic" securities seen
elsewhere, often with recourse to off-balance-sheet vehicles.
The depth of the crisis faced by our country nonetheless weighs on the outlook for banks.
Compared with the third quarter of 2007 gross domestic product has fallen by almost 9 per
cent and industrial production by roughly one fourth. It should surprise no one that banks are
encountering difficulties and struggling to support the economy fully. They suffered as a
result of the sovereign debt crisis and the ensuing deterioration of funding conditions in
international markets. The protracted recession continues to have repercussions on the
quality of loans, above all to firms. In some instances difficulties have arisen from
transactions that are incompatible with sound and prudent management, at times even
fraudulent. The supervisory action of the Bank of Italy has been intense; when necessary,
special administrative measures have been imposed.
In the second quarter of this year the annualized ratio of new bad debts to total bank loans
reached 2.9 per cent. Supervision - both off- and on-site - is closely monitoring the evolution
of credit and its quality. The objective is to make sure that the coverage ratios for
nonperforming loans remain adequate and are raised when necessary. Far from harming the
banks, our action will strengthen them, reassuring markets about the soundness of their
balance sheets. Bad debts amount to about €75 billion net of write-downs and are more than
covered for the system as a whole by collateral and personal guarantees. Other net
nonperforming loans (substandard, restructured and overdue loans), whose expected loss rates
are significantly lower than those of bad debts, amounted to about €110 billion.
Partly as a result of the checks carried out by us in late 2012 and early this year, the
coverage ratio for the aggregate of non-performing loans has stabilized. In June of last year it
was 39 per cent for the whole of the system and 41 per cent for the top five groups. The
average for the largest European banks is slightly higher (43 per cent), but the criteria for the
classification of impaired loans are less stringent than those adopted in Italy.
The measures contained in the draft Stability Law to reduce the time horizon over which
write-downs and loan losses are deductible remove some of the tax disadvantage that has
long penalized Italian banks compared with foreign competitors and that becomes even more
significant from the perspective of the Single Supervisory Mechanism. The new legislation, in
line with the recommendations issued on several occasions by the International Monetary
Fund, will encourage banks to adopt the most conservative practices when writing down bad
loans, thus improving the transparency of their balance sheets.
The gross profits of the banks amounted to €32 billion per year on average in 2011-12 and
to €17 billion in the first half of this year. Loan losses continue to absorb most of this,
however. If this situation were to persist for a long time, the low level of net profitability would
inevitably weigh on their financial situation.
The need to counter the effects of the crisis makes it urgent to address the structural
problems of the banking system, including those relating to governance. These are issues on
which I have already spoken in the past, but must return to because they remain largely
unresolved. The failure to solve them has a negative impact on banks' efficiency and
profitability and ultimately on the correct allocation of savings in the economy.
The ratio of operating costs to gross income, which amounted to 62 per cent in the first six
months of this year, is about 5 percentage points higher than the average for the leading
European banks. Taking into account the growth rate of lending, reduced unit margins and
weak demand for asset management products, in the current situation it is difficult to foresee
a significant increase in banks' revenues. In the short term the recovery of profitability
requires decisive action on costs, including labour costs, which represent more than half of
the total. Some progress has been made on this front, but we need all parties to participate,
and take responsibility, in an action not unlike the one successfully launched in the second
half of the 1990s to reduce the gap with the leading foreign banking systems. A major part of
this effort must consist in a rigorous review of executive compensation.
Cost containment requires a radical rethinking of the distribution channels to make full use of
the opportunities offered by technological innovation. Standardized and low-value-added
services can be distributed at lower cost through remote channels, and the traditional
distribution network should be reviewed to concentrate on the supply of more complex
products. It is not an easy task, and it requires a profound transformation of banks'
organization and operating structure and considerable investment in staff training. Targeted
mergers and acquisitions, based on robust economic premises, may facilitate the
restructuring and the recovery of efficiency.
The process of financial integration in the euro area is encouraging a wider use of
technology. The transition to the new payment standards under the Single Euro Payments
Area, which will be completed by 1 February next year, is an important element. It affects
firms, consumers, banks and other payment service providers. The availability of efficient
services will benefit the economy as a whole; according to studies sponsored by the
European Commission, the efficiency gains resulting from the transition to the new standards
will be in the order of 0.2 per cent of European GDP. The Bank of Italy is committed to
ensuring that all those involved in the initiative put in place the necessary organizational,
technical and procedural arrangements within the time limits.
Corporate reorganization, including within groups, and more streamlined boards are needed
in order to improve the chain of decision-making, by making directors more accountable and
eliminating unnecessary costs. Mechanisms must be adopted to prevent a misinterpretation
of banks' relationship with their local area from steering lending and investment activity in the
wrong direction, putting the soundness of banks' balance sheets at risk and hindering the
efficient allocation of resources.
In addition to disbursing credit, Italian banks often participate directly in firms' capital. Such
equity links must not be a source of distortions in lending decisions or give rise to attempts to
prevent debtors' difficulties from emerging. These risks, like all others deriving from
relationships with counterparties closely linked to banks, must be appropriately monitored by
banks' governing bodies. The supervisory authority cannot intervene preventively with regard
to individual transactions, even if they are with related parties. It will, however, continue to
exercise its control activity, carefully assessing the ways in which transactions are carried out
and their impact on banks' risk profiles and their sound and prudent management; it will
require any shortcomings to be corrected.
The business of the large cooperative banks is no longer restricted to a limited local area.
Their original corporate structures must not be an obstacle to the strengthening of their
capital bases. The stability of banks' ownership structure is of value, but it must be due to
good results and to high-quality governance arrangements, not to practices or rules aimed at
hindering the entry of new shareholders. Less fragmented share ownership can strengthen
the assessment of the performance of directors; the principle of one person, one vote can
remain a salient feature of small cooperative and mutual banks. For these reasons, as I have
argued on earlier occasions, it is desirable for large cooperative banks to adopt legal forms
open to assessment by the market.
Banking foundations should have diversified their portfolios to reduce their dependence on
the results of their reference bank. Some have not done so, they will have to adapt, taking
market conditions into account. All of them must be careful not to interfere in banks'
corporate structures and their business decisions, not to hinder the necessary renewal of
governing bodies, and not to influence directors' choices on the basis of criteria other than
experience and competence. Transfers from the top of foundations to the top of banks must
be avoided. Prompt and significant progress is needed on these fronts.
Banking Union
Banking Union is a milestone in the completion of the European Union. The Single
Supervisory Mechanism, comprising the ECB and the national authorities, constitutes the
first element. It will be accompanied by a single mechanism for the resolution of banking
crises and a harmonized system of deposit insurance, both of which are essential to align
supervisory responsibility with crisis management and resolution, in order to sever the link
between sovereign borrowers and banks. Work on these fronts needs to be accelerated.
The Single Supervisory Mechanism is expected to be operational in November 2014, one
year after the entry into force of the relevant regulation. It is a vast innovation that will require
a complex organizational effort at least equal to that needed to introduce the single currency.
The delicate start-up phase is taking huge investments in human resources and technical
infrastructure. The preparatory work is proceeding with the maximum possible speed; the
workloads of national supervisors will grow with the need to harmonize systems which are
very different. In November, the ECB will launch a comprehensive assessment of the
situation of the banks that will be supervised centrally (of which 15 are Italian); these banks'
assets represent 85 per cent of the euro-area banking system total. The exercise is a
prerequisite for the coming into operation of the Single Supervisory Mechanism and will last
twelve months; it will be carried out in collaboration with the national authorities and with the
support of independent third parties.
The evaluation includes three closely interlinked elements: a preliminary analysis of the
banks' risk profiles, an examination of the quality of their assets and a stress test. It will be
carried out using as a benchmark a ratio of 8 per cent between the banks' highest quality
capital (defined on the basis of the rules that will be introduced next year) and their
riskweighted assets. This is a threshold that ensures the availability of sufficient resources to
cope with possible difficulties.
The ECB and the EBA will conduct the stress test in close collaboration. The methods and
scenarios to be used for this exercise will be agreed and announced at a later time. Prior to
conducting the stress test, in fact, it is necessary that the results of the asset quality review
are suitably incorporated into the banks' financial statements.
The assessment is a critical juncture in the management of the crisis in the euro area and in
European integration. It represents a fundamental exercise of transparency, designed to
strengthen confidence in the banks' soundness and reliability and, where necessary, define
the appropriate corrective measures. It will be conducted rigorously, guaranteeing absolutely
equal treatment of all banks, which are now subject to highly heterogeneous supervisory
systems and accounting practices. The definition of non-performing exposures used will be
that recently adopted by the EBA, which is in line with the one used in Italy. Where data are
lacking, estimates will be employed.
The analysis will cover all types of risk and be based on current prudential rules. The risks of
highly opaque instruments will be assessed with special care. Account will be taken of the
diversity of methods by which banks using internal rating models calculate risk-weighted
assets.
The methodology of the exercise will be clearly explained, and the market will be informed of
the results and supplied with the information needed to evaluate them properly. The
involvement of outside experts, avoiding potential conflicts of interest, will enhance the
credibility of the exercise.
Together with the results of the assessment, the corrective measures required will also be
specified. Any capital shortfalls will have to be made good primarily by drawing on banks'
own resources, not distributing dividends, selling non-strategic assets, and curbing costs.
Where necessary, fresh capital will have to be raised on the market. The success of the
exercise depends crucially on having adequate national financial backstops, to be utilized in
conformity with European rules and the legal framework defined by national constitutions for
the ultimate purpose of ensuring financial stability.
Once the system is fully phased in, the rules for the operation of a European backstop will be
defined, to avoid a situation in which measures taken at national level could reaggravate the
vicious circle between sovereign risk and national credit market conditions. At present the
European Stability Mechanism cannot directly recapitalize banks; its funds can be used
indirectly for loans to member states. These loans, however, would increase their public
debt. Direct intervention is envisaged only once the Single Supervisory Mechanism is fully
operational. The implementing details are now being finalized.
* * *
The problems of the Italian economy stem from long-neglected structural weaknesses. They
have been exacerbated by the global financial crisis and the European sovereign debt crisis.
The reform action undertaken in the last two years must be continued resolutely and set
within a comprehensive framework, giving Italian citizens and domestic and foreign investors
alike the prospect of a country that can change and return to growth.
The efficient allocation of savings is a necessary condition for our economy to regain the
path of sustained, balanced growth. It requires a vital financial system that can support
entrepreneurial initiative and innovation and fuel a virtuous circle between economic growth
and saving.
The banks have a decisive role to play. The Bank of Italy's supervisory action - which we
perform in full observance of our powers and duties under the law - is directed to protecting
the savings of depositors and investors, to ensuring that their use is not distorted by
inappropriate corporate structures or misplaced local allegiance. But rules and controls are
no substitute for conduct guided by the principles of correctness and transparency, which
banks must also ensure through a suitable internal organization.
The exceptional monetary policy measures taken by the ECB Governing Council during the
crisis, and even before that the supervisory action of the Bank of Italy, have protected the
banks and the real economy against potentially catastrophic consequences. They have
helped to preserve the confidence of savers and investors. Banking Union, in the framework
of the broader process of completion of the European Union, can further stabilize conditions
in European markets if it is instituted rigorously and in its entirety. It will help to safeguard
savings by countering the sovereign risk component engendered by fears of euro
reversibility.
Italy's banks are feeling the repercussions of a financial and economic crisis for which they
bear no responsibility. But they are also suffering the consequences of slowness or failure to
adapt their business operations, efficiency, service quality and organization to the evolution
of the markets. They must continue to do their part with a courageous effort of renovation.