Ignazio Visco: Speech - Annual Meeting of the Italian Banking
Association
Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the Annual Meeting of the
Italian Banking Association (ABI), Rome, 5 July 2023.
* * *
Monetary policy and the economic and financial situation
Based on the overall assessment of the price outlook, the dynamics of core inflation - i.
e. net of the energy and food components - and the intensity of the transmission of
monetary policy to the economy, the Governing Council of the European Central Bank
(ECB) further raised the key interest rates in mid-June by 25 basis points, bringing that
on deposits held by banks with the Eurosystem to 3.5 per cent, 4 percentage points
higher than in July of last year. The Council also confirmed the discontinuation of the
reinvestments under the asset purchase programme, reiterating its intention to continue
those linked to the pandemic emergency purchase programme until the end of 2024.
The decisions will continue to be based, meeting by meeting, on an assessment of the
impact of new economic and financial data on the outlook for consumer prices in the
euro area, in order to guarantee a sufficiently rapid return of inflation to the 2 per cent
objective. Due in part to the marked tightening of financing conditions and the
pronounced weakening of credit, caution will be needed to avoid unwanted
repercussions on economic activity, on financial stability and on price stability in the
medium term. Monetary policy can count not only on increases in the reference rates
but also on keeping them at a level and for a period of time suitable for bringing inflation
back to the target. Now that these rates are in restrictive territory, calibrating how long
the monetary policy tightening lasts rather than excessively increasing its breadth would
have the advantage of favouring a more informed analysis of the effects of the action
taken so far.
Above all, the evolution in the risk perception of banks will need to be monitored. Past
crises have made it clear that this is an important driver of the intensity of a contraction
in credit supply. The quality of loans in the euro area has been modestly affected so far
by the worsening economic situation; the greater cost of debt triggered by the
considerable increases in interest rates could however cause it to gradually deteriorate.
The tightening would also be accentuated if the absorption of liquidity by the
Eurosystem led to a swifter and larger than expected increase in bank funding costs.
In Italy, the robust recovery of GDP caused by the full reopening of businesses after the
end of the public health emergency is fading. At a time when the international outlook is
weakening, tightened monetary policy aims to counter inflation and the support ensured
by fiscal policy has to be reduced, achieving an adequate and stable economic growth
will require a high level of public and private investment and the effective
implementation of structural reforms. The capacity of households and firms to respond
to unexpected and particularly violent shocks, such as those of the last three years,
must form the basis for public actions designed to make our economy less rigid and
slow. Over the next few years, the measures set out in the National Recovery and
Resilience Plan (NRRP) are expected to give a considerable boost to economic activity;
implementing its set of investments and reforms within the agreed time frame will be
crucial.
GDP returned to growth in the first quarter of this year, buoyed by the recovery in
consumption and by the further expansion in investment. As in the rest of the euro area,
the weakening of manufacturing activity was countered by the good results for private
services; in this sector, non-negligible rises in final prices are associated with the
healthy demand, especially in the tourism and leisure sector. Given the tighter financing
conditions and the slowdown in global trade, we expect GDP to increase moderately
over the next few quarters. According to the estimates published in mid-June, GDP
growth could exceed 1 per cent over the year, and should stay at around this figure on
average over the next two years.
These are forecasts that are still highly uncertain and with risks mostly on the downside.
Together with the conflict in Ukraine, which may lead to further rises in commodity
prices and a decline in the confidence of firms and households, there are fears
connected to the evolution of global economic activity, which could be affected to a
greater than expected extent by the monetary tightening under way in the leading
economies, as well as those linked to the risk of an excessive tightening of credit supply
conditions.
From December 2021 to May of this year, the interest rates on new loans to firms and
on new mortgages for households went up in Italy by around 360 and 280 basis points
respectively, to 4.8 and 4.2 per cent. The cost of bank funding is also on the increase,
but the effects of the rises in the key interest rates on those on sight deposits are still
very limited. This is partly attributable to the abundant liquidity accumulated by banks as
a result of the accommodative measures adopted over the last decade by the ECB
Governing Council to counter the risks of deflation, which remained in place during the
pandemic. This may have led to less competitive pressure among banks in the
overnight deposits segment, which should now gradually grow, with corresponding and
more decisive increases in interest rates.
In line with the central bank objective of achieving price stability in a reasonable time
frame, tightening financing conditions for households and firms is helping to curb
demand for credit. However, the surveys conducted on banks indicate that in Italy, as in
the rest of the euro area, growth in lending is also affected by the resolute tightening of
supply policies, mainly driven by greater risk aversion and concerns over growth
prospects. Credit dynamics, which were broadly positive until last summer, have turned
negative for both firms and households.
The modest rise in interest rates on sight deposits is favouring a marked reallocation of
savings towards more remunerative assets, particularly government bonds and, to a
lesser extent, towards other kinds of deposits and towards bank bonds. The
Eurosystem's reabsorption of excess liquidity and its effects on credit to the economy
are also contributing to the gradual contraction in overnight deposits.
Despite the altered circumstances and the persistence of great uncertainty over
changes in the economic outlook, the situation of the Italian banking system is
satisfactory overall. Profitability remained high in the first quarter; on an annual basis,
the return on equity was just below 13 per cent, as it continued to benefit from the
increase in net interest income and from loan loss provisions that are low also by
historical standards. According to market analysts' expectations, the profitability of the
main listed banking groups (which account for more than two thirds of the sector's total
assets) should also remain high in 2023 as a whole.
The CET1 ratio declined slightly in the first three months of the year, to 15.1 per cent,
as a result both of the end of the transitional regime introduced in 2018 with the entry
into force of the new accounting principles (IFRS9), which had spread the capital impact
over five years, and of the distribution of profits. Nevertheless, the indicator remains
more than one percentage point higher than was observed when the pandemic broke
out; for the significant banks, it is essentially in line with the average for the other
intermediaries directly supervised by the ECB. The liquidity indicators also stand at
levels well above the regulatory minimums. The repayment of part of the funds obtained
via targeted longer-term financing operations (TLTROs) has only marginally lowered
them so far.
As for the loan book, new non-performing exposures and their stocks remain at low
levels. The improvement in the quality of loans observed over the last few years is due
to the strengthening of firms' financial situations, as they have reduced their leverage
ratio by around 10 percentage points since the peak reached in 2011, to 39.7 per cent.
Contributory factors include the support measures introduced to mitigate the effects of
the pandemic crisis and the increase in energy costs. The reduction in non-performing
loans on banks' balance sheets has been helped by the growth of a secondary market,
which has allowed disposals to continue even at times of economic slowdown.
The greater capacity of intermediaries to select and manage credit risk has also played
an important role, especially during the loan origination, partly in response to the
stimulus provided by the supervisory authorities. Since 2014, following the sovereign
debt crisis, the weight of financially sound firms in banks' loan portfolios has grown
proportionally more than their share in the total assets of the whole corporate sector.
Nevertheless, uncertainty over the outlook for the banking system remains high. The
main risks stem from the cyclical slowdown and the medium-term effects of the
increase in interest rates on customers' ability to service their debts. Some potential
signs of these risks materialized in the first three months of this year: the ratio of the
flow of loans in arrears - but not yet late enough to be classified as non-performing
loans - actually doubled, on an annual basis, to 1.6 per cent of the total performing
loans.
Recently, however, the number of loans whose creditworthiness is reported by banks to
have deteriorated significantly (i.e. those ranked as 'Stage 2' in the hierarchy provided
by the international accounting standards) has decreased. This fall may be partly due to
the improvement in the quality of those exposures that fell into this category
immediately after the outbreak of the pandemic; we are monitoring their developments
to detect any underestimation of risks by banks. A timely recognition of expected losses
is also crucial to reduce the possible procyclical effects of the economic slowdown.
Ensuring adequate coverage for non-performing loans, especially for less significant
banks, is equally important.
In addition to increasing loan losses, pressure on profitability could occur if the
passthrough of higher official interest rates to the cost of funding, which is still gradual,
accelerated more than expected. The replacement of low-cost funding, such as that
from TLTROs, with more expensive instruments, and the need to issue new liabilities
that meet the resolution requirements could also play a role.
The risks posed by non-bank intermediaries remain limited, although they should not be
underestimated. Net subscriptions to Italian open-end investment funds remained
broadly unchanged in the first quarter; the few funds that recorded significant net
outflows (above 10 per cent of the net asset value) had no difficulties with redemptions.
In line with the context of rising interest rates, the liquidity of the funds decreased,
although it remains satisfactory. Credit lines remained stable and indebtedness
continued to be low.
The risks for Italian alternative investment funds are also limited; leverage is on average
lower than that of similar European funds and indebtedness towards banks is low. Real
estate funds, which are mainly active in the commercial sector, are among the most
leveraged funds. Although the likelihood of a sharp fall in prices in this market segment
is much lower in Italy than in other European countries, a further decline in the value of
commercial real estate would reduce the quality of bank lending to these intermediaries.
Supervisory issues
In recent years, once the most critical phase of the COVID-19 pandemic was over, new
risk factors have emerged in connection with the escalating geopolitical tensions, the
consequences of the energy crisis and the negative effects of climate change. It has
thus become increasingly important for supervisory authorities and for intermediaries to
use instruments that can capture potential vulnerabilities at an early stage. This is partly
why the supervisory review and evaluation process places particular emphasis - more
so than in previous years - on the reliability of internal procedures for assessing capital
adequacy and liquidity conditions. A number of tailored investigations were carried out
to gather additional information for assessment beyond that derived from regular
supervisory reporting.
In the first quarter of this year, similarly to what has already been done for significant
banks, those banks and other intermediaries under the direct supervision of the Bank of
Italy were requested to submit business plans updated considering the latest
macroeconomic scenarios. Based on this information, analyses are now under way to
assess the sustainability of business models and identify vulnerability factors, including
cost dynamics, in good time. The results of these studies will be an important basis for
our discussions with intermediaries.
In the same period, also in view of targeted longer-term refinancing operations reaching
maturity, we asked almost all less significant banks to update their funding plans, which
the ECB already systematically gathers for significant banks. On 28 June, around €150
billion of the €300 billion outstanding TLTRO funding was repaid. In keeping with the
plans, banks almost exclusively used excess liquidity, which has recently increased
thanks to bond issuance and repo funding. Recourse to new central bank refinancing
operations has been limited so far.
Banks should draw more heavily on these refinancing operations to cover future
repayments. Moreover, significant banks anticipate further issues of bonds - including
retail bonds - and, to a lesser extent, an increase in customer deposits. Smaller banks
claim that they will rely more on the latter. The idea of increasing deposit funding
clashes with expectations of a further reduction (at the aggregate level) in this form of
funding, which is already suffering from competition with alternative forms of
investment. At present, the extensive availability of assets eligible as collateral for
refinancing operations ensures that funding needs can be met, albeit probably at higher
costs than anticipated.
Non-bank intermediaries under our supervision are subject to rules that are in many
cases stricter than those in force in other European countries. In addition to refining the
supervisory review and evaluation process for these intermediaries as well, we regularly
check the systemic importance of alternative investment funds, whose assets under
management, although still limited, have doubled over the last ten years. We pay
special attention to credit and real estate funds.
Specific supervisory measures were taken for servicers to preserve the efficiency of the
secondary credit market, which has played a key role in reducing non-performing loans
on banks' balance sheets through securitization operations. Initial results reveal
shortcomings in governance and control, as well as delays in updating recovery plans.
The ongoing discussion aims to assess the adequacy of the remedial measures, also
with a view to improving the quality of the information provided to the market on the
performance of managed operations. Some of these operations are lagging behind the
initial recovery plans, partly due to the suspension of enforcement proceedings during
the most acute phases of the pandemic. As for government-guaranteed operations, the
older ones have the largest deviations as their recovery plans were drawn up less
rigorously.
The recent rise in market yields has also increased the interest payable to holders of
bonds, often at floating rates, issued by special purpose vehicles against
nonperforming loans thus reducing the share of the collection used to repay the principal.
At the end of 2022, the total amount of outstanding government-guaranteed senior
bonds was around €12 billion. If we consider the few operations whose recoveries,
according to the updated plans, would not be sufficient to fully repay the senior bonds,
the total enforced guarantee could amount to around €220 million. However, this sum
should be covered by the provision funded by fees paid by banks for granting the
guarantee and by the amounts already earmarked in the public budget for this purpose,
without the need for further government funding.
Some recent regulatory reforms have addressed specific intermediaries' business lines,
such as crowdfunding services, and specific products, such as covered bonds and
securitizations. This has resulted in potentially more effective safeguards. However, to
maintain a comprehensive overview of the risk exposure of supervised entities, we
should always consider these operations as part of their overall corporate management.
In this respect, we are committed to strengthening cooperation and dialogue between
the various authorities involved.
Financial services and technology
Technological innovation is reshaping the financial services industry, making it possible
for intermediaries to overcome the barriers created by the need for physical interaction
with customers, to achieve cost savings, and to test new forms of cooperation with
supervised and non-supervised entities. While intermediaries should seize these
opportunities by adjusting their business models as needed, neither they nor the
supervisory authorities should underestimate the risks of technological change.
Last year, we conducted a survey of the digitalization strategies of the less significant
banks to encourage debate on these issues. We found widespread awareness of the
importance of investing in technological innovation, albeit only as a means to increase
business volumes and revenues by reaching customers who cannot be served by the
physical distribution network. The potential for development in terms of cost-cutting and
of process and product innovation was less of a consideration. More marginal still was
understanding the value of the information acquired in the context of financial
intermediation. Developing good data processing and control capabilities is instead key,
not only to responding promptly to information requests from the supervisory
authorities, but especially to providing timely reports for corporate executives to make
informed decisions.
Digitalization fosters cooperation between financial intermediaries and technology
service providers. This can result in efficiency gains for the financial industry and
higherquality services for users, but authorities and operators alike need to improve their
ability to assess the risks associated with this process. We are about to launch new
supervisory reporting on outsourcing, which will allow us to gather information on
supervised entities' contracting arrangements as well as valuable input for assessing
the degree of concentration among the leading service providers and ultimately to
minimize the impact of any incidents.
On-site inspections of the main IT service providers used by the less significant banks
have shown that there is more dialogue between the parties, which is essential both to
monitor risks better and to design digitalization strategies. However, dialogue can only
be truly effective once corporate executives have honed their IT skills: as of now, just
half of the less significant banks reported having at least one director with specific
expertise, and the share of control function employees with these skills remains low.
These initiatives come ahead of the European Digital Operational Resilience Act
(DORA), to be enforced as of 2025 to ensure that European supervisors adopt a shared
approach to digital resilience across the entire financial services industry. They allow
the Bank of Italy both to bring its experience to the authorities that are drafting
secondary legislation and to better prepare banks for the 2025 deadline.
We are working closely with the Ministry of Economy and Finance (MEF) and with
CONSOB on the implementation of the European Markets in Crypto-Assets Regulation
(MiCAR) in Italy. The regulation also classifies these financial instruments based on
their different economic functions, introduces a harmonized legal framework for them,
and therefore indicates how the roles and responsibilities should be distributed among
the distinct supervisory authorities.
However, we are aware that it will not solve all the problems stemming from the
evolution of the markets, as unhosted wallets (i.e. digital wallets used to exchange
crypto-assets without the involvement of an intermediary) and the development and
application of smart contracts (i.e. computer programmes at the core of decentralized
finance) remain outside its scope. This is also why, one year after the publication of our
communication on Decentralized Technology in Finance and Crypto-Assets, in which
we provided specific instructions for operators, we are assessing the outlook for these
services and future market developments.
As I have pointed out on several occasions, crypto-assets are only one of the
applications of distributed ledger technology (DLT). The introduction of the DLT Pilot
Regime in Italy, as well as in other EU countries, will allow operators to experiment with
the use of DLTs in order to reduce the costs associated with the issuance, trading and
settlement of financial instruments and to broaden the investor base for securities
issued by Italian entities. This could bring tangible benefits to firms, especially
mediumsized ones, in terms of better access to capital markets and diversification of funding
sources. With this in mind, we are working closely with CONSOB to design secondary
legislation and to facilitate the projects of market players. Within the Eurosystem, we
are also testing some technical solutions, including one designed by the Bank of Italy,
to ensure that DLT transactions can be settled in central bank money.
Financial intermediaries are interested in developing open banking interfaces for
thirdparty access to payment accounts, as laid down in the second Payment Services
Directive (PSD2), and this is gradually fostering market competition, also thanks to new
entrants. The European Commission's legislative proposal on open finance, published
on 28 June 2023, could further boost competition because by using a wider set of
customer data, operators will be able to develop new financial products and services.
Moreover, while paying close attention to monitoring technological risks, intermediaries
must continue to ensure adequate customer protection and effective anti-money
laundering safeguards.
The increasing amount of information generated and made available as a result of
digitalization is contributing to a growing uptake of artificial intelligence (AI) applications
in the financial industry as well, with potential consequences that are still extremely
difficult to grasp. In this regard, it is worth mentioning the ongoing European
negotiations to create a harmonized legal framework to regulate the development,
marketing and use of AI in accordance with the EU's values and its Charter of
Fundamental Rights. Although the regulation is cross-cutting in nature, it has several
aspects that are also relevant to the financial industry; its spillover effects on
intermediaries' operations and on customer protection will have to be assessed
carefully.
The Bank of Italy is well aware of the progress being made and it supports and
promotes digital innovation in the financial system throughout the service production
cycle, while monitoring the ensuing risks closely. Our work is focusing on the
sustainability of business models, the security and efficiency of market infrastructures,
updating the regulatory framework and the risk management processes, as well as on
consumer protection and financial education on the new instruments and new ways of
using those services made available by technology.
Through ongoing dialogue with market operators (via the Fintech Channel, Milano Hub,
our innovation centre, and the activities carried out within the regulatory sandbox), we
support their projects from the design and development stages through to testing. In
view of the growing interest in the use of DLT, Milano Hub's second call for proposals
focused on the application of this technology to banking, financial, insurance and
payment services. The large number of applications is evidence of its success. The 14
winners are now developing their projects with the multidisciplinary assistance of
experts from the Bank of Italy.
On the payment systems front, we have supported the MEF in its work within the
European Council on the proposal for a regulation on instant bank transfers in euros, a
milestone in the process of building an integrated, innovative, digital and competitive
European payments industry. The regulation aims to overcome some of the obstacles
to the widespread use of instant bank transfers, namely the fees currently charged for
these transactions and the public's mistrust of this type of payment. Therefore, fees on
instant transfers should not be higher than on traditional transfers in euros, and banks
would be required to put systems in place for verifying that the payee's name matches
the bank details as entered by the payer.
Again on 28 June, the European Commission presented a proposal for a regulation on
the possible introduction of a digital euro. The proposal describes the reasons and
goals for a new form of central bank money available to the public and contains a broad
set of rules regarding, among other things, the legal basis, the role of the Eurosystem
and of credit institutions, and the use and protection of users' personal data.
Negotiations have just begun. In order for the digital euro to play an anchoring role in
the public's trust in central bank money, it must have the status of legal tender, on a par
with banknotes, and the highest level of privacy compatible with the public interest,
including the need to bar its use for money laundering and the financing of terrorism.
Any decision to issue this new form of money will be taken by the ECB Governing
Council once the necessary regulatory framework has been completed.
The digital euro is an important project, not only to promote competition and innovation
in the European payments system with lower costs for users, but also to preserve the
euro area's strategic autonomy and monetary sovereignty. In order for it to be
successful, it will be necessary to design incentives that encourage all stakeholders to
join in: consumers and firms, because they will be using the digital euro, and banks and
other institutions, because they will be distributing the new money and providing the
associated services.
The digital euro should be used as a payment instrument and not for saving purposes.
We must therefore first consider the risks for monetary policy transmission and financial
stability that could arise from substituting an excessive amount of bank deposits with
digital currency. As a central bank liability, the digital euro will be a risk-free form of
money like notes and coins, to be used alongside cash and other payment instruments
already in use but without necessarily replacing them. The solutions under
consideration include in particular the absence of any remuneration and a threshold for
the amount of digital currency that a user can hold. The solutions will have to preserve
banks' capacity to provide credit to the economy and, at the same time, avoid the
possible uptake of high-risk instruments, such as some types of crypto-assets, as a
means of payment.
Supporting the climate transition
Today the banking system is facing the challenge of the green transition. While in the
medium term, the contribution of the financial system will be fundamental in achieving
the decarbonization goals agreed at global level, it should be prepared, as of now, to
manage climate and environmental risks.
The recent flooding in Romagna and the surrounding territory reminded us how extreme
weather events can not only cost human lives, destroy homes and disrupt the lives of
people in the affected areas, but they can also have serious consequences for
businesses and, hence, for the banks that provided them with funds. The areas in
question generate around 3 per cent of the value added of the national non-financial
private sector and a similar share of total bank loans. More generally, the Bank of Italy's
estimates show that, in Italy, around one fourth of loans to non-financial firms are aimed
at businesses in provinces at high risk of natural disasters. Of these, 58 per cent are
covered by guarantees, which could, however, be exposed to the same risk as the
loans; the coverage ratio falls to 38 per cent if only personal guarantees are taken into
account.
There is urgent need for action, in the first place to contain the risks. Follow-on
interventions - funding of reconstruction work, infrastructure repairs, the suspension of
various tax payments and utility bills, and loan repayment holidays - will certainly
mitigate the economic impact of adverse climate events but they cannot be seen as the
solution. The first line of defence must be to secure the country against flooding and
landslides, bearing in mind that this is far costlier to achieve after the event has taken
place. To this end, the NRRP has earmarked about €1.25 billion. The contracts for this
work will be awarded by the end of 2023 and the delays signalled in the last report on
the implementation of the NRRP must be prevented from becoming any longer.
The private sector can also make an important contribution by stipulating insurance
policies to cover damage caused by natural catastrophes. A significant expansion of
this market could reduce the currently high cost of these policies. Italy is still very
behind in this area: in the period 1980-2020, only 6 per cent of the losses connected
with such events were covered by insurance on average, compared with 22 per cent in
Europe. The lack of insurance cover seems to be prevalent among the smallest
companies and those located in the South and Islands. As part of the coordination
group on sustainable finance set up at the Ministry of Economy and Finance, in which
we participate together with IVASS and the other authorities in the sector, we have
launched an initiative to promote insurance protection against climate and other
catastrophe risks, based on the public and the private sectors working together.
Adequate insurance cover is also an important factor in risk mitigation for banks that
lend to households and firms located in areas with high climate risks. However, in about
three quarters of cases, banks are not aware that their borrowers are insured, which
means that they might not take this into account when setting out their credit supply
conditions. If confirmed by further evidence, it will be necessary to investigate in greater
depth with banks and firms why this is the case, and to remedy the situation.
We have asked banks and financial institutions for three-year action plans showing how
they intend to meet the supervisory expectations we published in 2022. As is already
the case for the significant banks, the evaluation of these plans will be included in the
Supervisory Review and Evaluation Process (SREP), taking a proportionate and
gradual approach. Such plans must be based on reliable data that are as accurate as
possible.
In this regard, we are participating in numerous international and national working
groups. In particular, in the group chaired by the Ministry of Economy and Finance to
which I referred earlier, action is being taken to reduce the information gaps and to
improve the quality and availability of data on the environmental (and social and
governance) aspects of the activities of both banks and their borrowers. At the moment,
our contribution is based on an analysis of the difficulties faced by the largest banks -
which, since last year, have been required to disclose information to the market based
on the third pillar of the Basel framework - in retrieving sufficiently good quality data.
Similar difficulties were experienced by the smaller banks and the other financial
institutions that, according to the 2020 Regulation to facilitate sustainable investment,
are required to publish their exposures using the EU's taxonomy, as defined in the 2021
Commission Delegated Act.
Credit allocation will have to be based on forward-looking assessments, meeting as far
as possible the demand of firms that commit to ma