Ignazio Visco: Overview of economic and financial developments in Italy
Concluding remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Ordinary
Meeting of Shareholders 2014 - 121st Financial Year, Bank of Italy, Rome, 26 May 2015.
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Ladies and Gentlemen,
Last year was one of important changes: in Europe, by reason of the evolving institutional
context and major economic and monetary policy decisions; in Italy, by reason of the
quickening pace of the reform effort. It was a year of difficult choices, whose early results -
significant but still fragile - must be resolutely defended. The economic recovery that got
under way in Italy in the first quarter of this year is likely to strengthen in the current and
subsequent quarters.
For the Bank of Italy, 2014 was a year of engagement in the euro area in formulating and
implementing monetary policy and launching the Single Supervisory Mechanism, and in Italy
in enhancing our services to the national community and further modernizing our
organization and operations.
The Bank of Italy's total assets declined by nearly €24 billion, to €530.6 billion, reflecting a
reduction in Eurosystem refinancing operations. This year the implementation of the
extraordinary securities purchase programmes will expand our balance sheet again.
Our gross profit fell from €6.9 billion to just under €6 billion in 2014. Today the Board of
Directors proposes that this meeting allocate €1.8 billion to general risk provisions and
€750 million to statutory reserves. Taking market conditions into account, it also proposes to
distribute dividends of €340 million to shareholders. On the basis of the indications laid
down in the Statute, €1.9 billion goes to the State, in addition to a tax liability of €1.2 billion.
At its meeting on 30 April the Board of Directors determined that in future years dividends
should ordinarily be in the range between last year's and this year's amounts, conditional on
the size of net profit and on capitalization needs, unless the general conditions of the
financial markets or the Bank's profitability have undergone significant changes. The
commencement of the redistribution of holdings of the Bank's shares, as required by law,
may be facilitated by awareness of this orientation. Meanwhile the Bank is working on the
dematerialization of the shares. Once the new system is fully phased in, transfers will be
made electronically in a dedicated market segment, so as to make the investment liquid.
The Report on Operations and Activities, which we present today together with our Annual
Report, describes in detail the tasks carried out, organizational developments and resource
management in 2014.
Practically 40 per cent of the work done by the Bank of Italy's staff relates directly to our
participation in the Eurosystem and the Single Supervisory Mechanism. Our technical
structures are heavily and constantly engaged in the committees and working groups acting
in support of the decisions of the ECB Governing Council.
Designing and implementing the monetary policy for the euro area draws on a broad range of
competences in the fields of economic analysis and market intervention. To date, nearly a
third of the total liquidity supplied by the ECB's targeted longer-term refinancing operations
has been taken up by Italian banks. For the Bank of Italy, the outright purchase programmes
of private and public securities have entailed daily market interventions averaging
€450 million.
The launch of the Single Supervisory Mechanism has required an extraordinary allocation of
resources. We have taken part in its construction by making our knowledge and experience
available. The new European system of banking supervision has been designed as a
"system of authorities". The ECB and the national authorities agree jointly on decisions and
practices. The ECB has direct supervisory responsibility for the 123 most important, or
"significant", banks; decisions are taken by the Governing Council acting on a proposal from
the Supervisory Board on which the national authorities sit.
Each of these banks is supervised by "joint supervisory teams" consisting mostly of staff
drawn from the national authorities - chiefly but not exclusively those of the country in which
the bank is headquartered. The Bank of Italy has assigned 58 of its analysts to the teams
supervising Italian banks, and another 20 to 18 groups responsible for supervising non-Italian
banks. Finally, 60 Bank of Italy inspectors are assigned to on-site inspections at significant
banks. The number of experts involved in these activities will grow further already in the
coming months.
The new arrangement is complex; it seeks to balance an overall vision with immediate and
effective action that makes the most of the national authorities' accumulated knowledge and
expertise. The result is a network architecture in which every significant bank is examined by
many eyes of diverse nationalities.
The Bank of Italy dedicates considerable resources to the oversight of market infrastructures
and the provision of European-wide payment services. The migration to the new Single Euro
Payments Area for retail payments has been successfully completed. With the Deutsche
Bundesbank, the Bank of Italy operates the TARGET2 settlement system for payments
within the euro area, and we will also operate the TARGET2-Securities platform for settling
securities transactions.
For the "less significant" intermediaries, supervisory responsibility and direct supervisory
action are left to the national authorities, within the framework of the common mechanism. In
Italy, this covers 56 banking groups, 435 non-group banks, and 77 branches of foreign
banks, plus 456 non-bank financial intermediaries also subject to our prudential supervision.
The Bank of Italy is also tasked with activating macroprudential policies to safeguard the
overall stability of the financial system. When enlarged to include two additional members,
our Governing Board also takes externally relevant decisions concerning insurance
supervision prepared by the Insurance Supervisory Authority.
As part of our action to protect the consumers of banking and financial services, inspections
focusing on transparency and correctness in customer relations were carried out at
124 intermediaries in 2014. In 71 cases shortcomings were detected and actions taken to
overcome them and improve service quality. The public is increasingly sensitive to this issue.
We received nearly 14,000 complaints last year, 2,200 more than in 2013, and we take them
into account in our supervisory action. Appeals to the Banking and Financial Ombudsman
increased by 40 per cent to over 11,000, with more than two thirds of the 8,500 rulings
favourable to customers.
The Financial Intelligence Unit was reorganized and its analytical capability reinforced.
Thanks to investment in skills and technology, together with the dedication of its staff, the
Unit handled the steadily rising number of suspicious transaction reports, which has more
than tripled over the past five years to 72,000. It further shortened its response time last year,
informing the law enforcement and judicial authorities more and more promptly.
In recent months we have decided on a new rationalization of our branch network following
that completed in 2010. By the end of 2018 the number of branches will be reduced to 39,
down from 58 today and 97 in 2007.
The new configuration takes account of developments in technology, concentrating activities
and personnel in larger units endowed with specialized professional skills that are updated
constantly; it will improve service quality, maintaining a balanced territorial presence. The
duties of the branches will be extended in the areas of consumer protection, supervision of
non-bank intermediaries, assessment of asset eligibility for monetary policy operations, and
inspection and control of cash circulation.
Today the Bank has 7,100 employees, including nearly 170 seconded to other institutions,
primarily the ECB. In 2009 we had a staff of over 7,500. In the past five years the Bank's
operating expenses have diminished by more than 14 per cent in real terms, thanks above
all to measures to curb current expenses.
With investment in technology, among other things, our drive for organizational improvement
will proceed. In managing human resources we will continue to adapt to social and economic
changes. In agreement with the trade unions we have enhanced flexibility in working hours.
We will reinforce the areas whose workload has been made heavier by the new European
arrangements. We will continue to invest in people, seeking out and rewarding excellence,
fostering career-long development of skills and promoting diversity.
On behalf of the Board of Directors, the Governing Board, and myself personally, let me
voice our appreciation and gratitude to the women and men who work at the Bank of Italy,
whose integrity and capability have always constituted the strength of this institution.
Monetary policy and economic growth in the euro area
The past year saw a slowdown in the emerging economies, related to the dwindling stimulus
of commercial integration and the emerging effects of structural fragilities. Developments in
the advanced countries diverged. Economic activity in the euro area remained weak for
much of last year. Within the area, growth differentials narrowed but the remaining cyclical
differences were reflected in the labour market: the increase in employment was robust in
Germany and Spain, very modest in France and Italy. Although the unemployment rate fell
slightly it was still high, especially among young people. Inflation continued to decrease, with
the change in consumer prices turning negative at the end of the year.
We have emphasized on several occasions the risks stemming from a prolonged period of
exceptionally low inflation, if not outright deflation. Studies carried out by the Bank of Italy
show that the price deceleration is largely due not only to the drop in energy costs, but also
to the lack of aggregate demand. They confirm that there is a risk of disanchoring of inflation
expectations, which have reached an historical minimum. They point to the potentially heavy
cost of low inflation, especially in conjunction with high levels of public and private debt.
In view of these risks the Governing Council of the ECB cut its policy rates to the lower
bound, started new targeted longer-term refinancing operations, and launched covered bond
and asset-backed securities purchases. In January of this year it decided to extend its asset
purchases to public sector securities.
Under the expanded asset purchase programme the ECB will make monthly purchases
amounting to €60 billion until the end of September 2016, and in any event until it sees a
sustained adjustment in the path of inflation consistent with a return to price stability. This
action will restore the Eurosystem's balance sheet to the peak levels recorded in the first half
of 2012. About €150 billion worth of Italian government securities will be purchased, of which
more than €130 billion by the Bank of Italy and the remainder by the ECB.
The single national central banks will bear the risks associated with the government
securities they purchase. This decision takes account of the concerns of some members of
the Governing Council that the programme could lead to transfers of resources between
countries. Full risk sharing would have been more in line with the singleness of monetary
policy and consistent with the Treaty on European Union. However, the measure's
effectiveness is undiminished: it depends above all on the scope and timing of the action.
The decision in favour of only partial risk sharing reflects the delays and limitations of the
process of European unification.
The asset purchases boost economic activity and raise inflation through several channels:
they reduce yields on public sector securities, with effects on other segments of the financial
market and on the conditions for credit to households and firms; they cause a depreciation of
the euro, which impacts on imported inflation and on exports; they increase the value of
financial assets and hence the private sector's spending capacity; and they improve inflation
expectations and public confidence.
Positive effects on the financial and foreign exchange markets emerged as soon as the
preparation of the programme was announced. From the beginning of November, and
despite a rise in recent weeks that mainly reflected improved growth and inflation
expectations, yields on ten-year German and Italian government securities have fallen by
about 20 and 60 basis points respectively. The euro has depreciated by more than 10 per
cent against the dollar and by 6 per cent in nominal effective terms. The stimulus has spread
to market segments not directly affected by the asset purchases and to credit supply
conditions. Inflation expectations have begun to improve, though only slightly.
Fears of deflation have abated, but the positive effects of the programme observed so far
should not weaken our determination to take it forward; on the contrary, they are confirmation
that we need to carry it through to the end. Improvement depends on the credibility of this
commitment, and the cost of non-completion would be very high. Inflation must be brought
permanently back to levels consistent with an annual growth in consumer prices of below but
close to 2 per cent in the medium term.
With the start of purchases we have entered a new, partially uncharted, territory of extremely
low interest rates even on medium- and long-term maturities. In seven euro-area countries
these are now negative on horizons up to three years. In the second half of April, just before
the recent increase, German rates were negative on maturities up to nine years. Fears have
been voiced that the programme could encourage excessive risk taking in the search for
higher yields, that it could generate liquidity tensions in some market segments, and harm
some categories of financial operator such as insurance companies and pension funds.
These risks must be carefully weighed but not overestimated.
There are no signs to date that low interest rates are provoking generalized imbalances. In
the euro area as a whole, financial asset and property prices do not appear to be under
speculative pressures, investors' risk propensity is still low, and credit growth is weak. Local
and sectoral tensions can be controlled with macroprudential measures, as happens already
in some other euro-area countries. Asset purchases are being made gradually and
continuously so as not to distort price formation; securities lending by the ECB and some
national central banks, including the Bank of Italy, is helping to keep the secondary market
liquid.
The potential repercussions for specific sectors are not being ignored. The EU-wide stress
test carried out in 2014 revealed that the exposure of insurance companies to the risks of a
prolonged period of low interest rates is significant in some euro-area countries; it is less
marked in Italy, thanks to a basically balanced financial structure. Insurance companies can
limit these risks by seeking a better match between the yields and duration of balance-sheet
assets and liabilities, improving operating results through diversification of portfolio securities,
increasing technical reserves and, where necessary, adjusting their obligations to
policyholders to the new market scenario. The authorities should step up their supervisory
action and prudential controls as recommended by the European Insurance and
Occupational Pensions Authority.
The risks, both real and financial, would have been far greater had we not begun the asset
purchases. The greatest threat to the euro area's financial stability comes from the prospect
of a stagnation of production and low inflation, which the programme combats.
Signs of a recovery of economic activity in the euro area have gained strength since the end
of 2014. According to the latest projections, output growth will acquire a solid basis this year
and gain momentum in the next, largely thanks to the support of monetary policy. There is
still the risk of a further weakening of productive activity in the emerging countries and of a
sharpening of international tensions.
The flare-up of the Greek crisis has had few repercussions to date on sovereign risk
premiums in the rest of the area thanks to the reforms undertaken in many countries, the
progress made in European governance and the tools available to the authorities to
prevent contagion. Still, the difficulties that the Greek authorities are having in designing
and implementing the necessary reforms and the uncertainty surrounding the outcome of
their prolonged negotiations with European institutions and with the International Monetary
Fund are fuelling grave tensions that could prove destabilizing.
Monetary policy cannot guarantee strong and lasting growth on its own. In the short term,
demand can draw support from a reasonable use of existing flexibility within the limits of
European budgetary rules. As the European Commission too has said, a contribution could
come from the countries with the smallest debt and soundest public finances. The
Investment Plan for Europe must be implemented without delay. Broader action would
require an autonomous fiscal capacity for the euro area. Going forward, this capacity could
be achieved by introducing built-in business cycle stabilizers, a first step towards true fiscal
union.
In the medium term the creation of new income, new demand, and new jobs must be
supported by measures and reforms designed, as of now, to raise productivity and growth
potential. Technological progress brings about a marked expansion in activities that
require expertise and new skills, but it can reduce, even considerably, the scope for
employment in the sectors most susceptible to automation and to the growth of the digital
economy. These consequences can be mitigated by developing new occupations, even in
traditional sectors, that are less amenable candidates for automation. But investment is
needed in infrastructure, education and training, and steps must be taken to make the
labour market more efficient and minimize the fall-out for individual workers during the
transition period. The support that monetary policy provides to aggregate demand is not
an alternative to reform but it makes it possible to speed up the process and more easily
absorb the short-term costs.
The Italian economy: consolidating the recovery
The recovery has now begun in Italy as well, albeit on a weaker basis than in the euro area
as a whole. The expansion of exports has been accompanied by a recovery in domestic
demand. The acceleration of household spending continues, especially on durable goods,
mainly thanks to the improved outlook for disposable income. Investment returned to growth,
and business surveys indicate that it could strengthen during the year. The increase in GDP
in the first quarter ended a long period of unfavourable cyclical conditions; output is expected
to continue to expand in this quarter and in those to come.
A return to stable growth that can provide new job opportunities requires a continuing drive
for innovation, which is necessary to adapt to new technologies and global competition.
Progress on this front in the last few years has helped restore Italy's balance-of-payments
surplus on current account, which came to almost 2 per cent of GDP in 2014. Since 2010 the
overall adjustment has exceeded 5 percentage points, reflecting cyclical effects as much as
structural adjustments.
Italian firms' renewed capacity to compete is signalled by growth in the volume of goods
exports that is greater than that in demand on our outlet markets, in particular those outside
the euro area. The performance of the most efficient businesses that have increased their
sales abroad, made investments and innovated, contrasts with that of a considerable part of
the productive economy, which is characterized by a low propensity to innovate and more
traditional organization and management.
There is less innovative activity in Italy than in the other major advanced economies,
particularly in the private sector. The latest European survey on innovation indicates that the
lag, especially marked in comparison with Germany, is more noticeable in the high-tech
industries. Italian firms have much less capability for in-house research and development
and for cooperation with universities and other advanced training institutions.
Compared with those in other advanced countries, firms in Italy not only start out smaller but
also struggle to expand; even when they are successful they expand their work force more
slowly and for a shorter period. As we have often noted, apart from the financial limitations
that I will discuss later on, the barriers to firms' activity and growth are mainly to be found in
the environment in which economic activity takes place. The complex regulatory system, the
relative inefficiency of public procedures and government action, the slowness of the justice
system, and shortcomings in education and training all hinder the reallocation of productive
resources to the most efficient firms, which is one of the main mechanisms of productivity
growth. This situation is aggravated by corruption and, in several areas, the presence of
organized crime.
In the last two years there has been a significant recovery in foreign capital inflows for
portfolio investment, including bank and corporate equity and bonds. Nevertheless, the
barriers to the renewal and expansion of Italian firms continue to discourage direct
investment in Italy. Such investment is an important factor for change in management, for
innovation, and for productive and commercial positioning within international networks.
Despite signs of vitality, foreign direct investment in Italy is modest by international
standards.
Reforms to remove the barriers to Italy's development have been undertaken and have
gained recognition from international institutions and markets. In order not to disappoint the
expectations of change, the spectrum of the reforms must be broadened and their
implementation accelerated. In some cases, the benefits will not be immediate, but this is all
the more reason to act without delay, pursuing a comprehensive design.
The recent labour market reforms have extended the income support mechanisms for the
unemployed and, for newly hired workers, reduced the disincentive to permanent hiring
connected with uncertainty over the outcome of decisions to terminate employment
contracts. A full evaluation of the effects of these measures is premature. Trends in
employment still reflect weak demand and ample unutilized production capacity. The sharp
rise in new permanent contracts at the start of 2015, partly encouraged by the substantial tax
relief in force from January, is a positive sign, suggesting that as the recovery takes hold,
employment may grow and be oriented towards more stable forms.
There is still the risk, however, especially in the South, that the recovery will not be able to
create jobs to the same extent as in the exits from past recessions. The crisis came on top of
the great transformation dictated by technological progress and increased integration
between different economies, with the large emerging countries among the protagonists.
Labour demand from the most innovative firms may not be sufficient to reabsorb all the
unemployment in the short term. This would affect the very sustainability of the recovery
since domestic demand would not fuel it sufficiently.
This risk must be countered by supporting, including with innovation, activity in sectors where
Italy has important traditions but also serious shortcomings and where production still
depends on substantial inputs of labour, diversified according to skills and knowledge.
Greater attention and greater public and private investment in urban modernization, land and
landscape protection, and the exploitation of our cultural heritage can bring important
benefits, combining innovation and employment, and not only in such directly involved
sectors as construction and tourism.
In this delicate phase, special importance attaches to the full integration of the active and
passive labour policies outlined in the enabling act for labour market reform. It will be easier
to keep pace with technological innovation if the requisite skills can be acquired through
effective retraining and if income support allows the unemployed to undertake such retraining
with dignity. As regards young people, schools must provide the prospect of a reasonable
return, not exclusively economic, on their investment in knowledge. For some time many
indicators have shown that Italy lags behind in both educational attainment and skills. To
improve the curriculum, enhance quality and channel resources to where they are needed,
requires first of all a systematic and in-depth assessment of the services provided and the
knowledge and skills acquired.
Our Annual Report, with its new format and content, this year includes an in-depth
examination of the public administration. Our business opinion surveys clearly show that there
are difficulties stemming from an excess of bureaucratic requirements and an unstable
regulatory framework. International comparisons place us quite far down the rankings, even if
in every part of Italy backward and virtuous situations coexist. The renewal of the public
administration, which began several years ago and is one of the Government's explicit
objectives, is also the condition for carrying out a review of public spending that can preserve
and improve the quality of services.
In a situation that remains difficult, fiscal policy has sought to balance rigour with support
to the economy, in accordance with the margins for flexibility allowed under the
European rules, while keeping the deficit under 3 per cent of GDP in recent years.
Following the severely restrictive measures necessitated by the crisis of confidence in
2011, it has been proper to dose fiscal consolidation measures carefully so as not to
hinder the recovery.
Thanks in part to the reform of the public pension system, in Italy more than in other
European countries the long-term sustainability of the public finances can be preserved.
Nevertheless, since the onset of the financial crisis the debt-to-GDP ratio has risen by more
than 30 percentage points to 132 per cent, owing above all to the lack of economic growth. A
return to higher levels of growth of nominal income, together with still prudent fiscal policy,
will make the rapid reduction of the debt ratio possible.
Banks and the financing of the economy
The global financial crisis and its repercussions on the economy have prompted a
widespread revision of the rules governing the financial system at international level.
Vigorous measures have been taken both in the sphere of banking supervision and at
macroprudential level with a view to restoring and preserving financial stability.
In the euro area, Banking Union has been set in train rapidly after a discussion of the
essential points between the European institutions and the governments of the member
countries. In Italy, measures have been adopted or are being studied to strengthen the
banking system, debilitated by the long recession, and enable it to support the recovery of
the real economy.
In the past months Parliament has reformed the cooperative banking sector. The biggest
cooperative banks have long outgrown the confines of local markets. Like the other large
Italian banks, they are now facing the changes imposed by economic integration and by
technology. The cooperative form has deterred assessment of these banks by investors and
impeded their ability to access the capital market swiftly, a crucial factor at times for coping
with external shocks. The reform will facilitate efficient credit intermediation in a market made
more competitive by Banking Union.
The need for the banking foundations to perform their role of shareholder while respecting
the investee banks' management autonomy and to diversify their investments is a point that
the Bank of Italy has stressed for some time. The Memorandum of Understanding between
the Ministry of Economy and Finance, responsible for supervising the foundations, and the
Association of Banking Foundations and Savings Banks is a step in this direction. The
concentration limit on investment in a single issuer protects the interests of both the
foundations and the banks. The Memorandum safeguards compliance with the ban on
control, including joint or de facto control, of investee banks. It also improves the quality of
governing bodies, increasing their degree of independence.
For mutual banks to be able to continue to support their local markets and communities,
preserving the spirit of mutualism that is their hallmark, it is necessary to pursue forms of
integration based on membership of banking groups. Scant diversification of risk and the
difficulty of capital strengthening are creating crisis situations in more than a few cases. The
mutual banks' trade association is drafting concrete proposals that will be evaluated in the
light of their ability to remove the obstacles to recapitalization and to resolve these banks'
problems. Change cannot be delayed.
Signs of improvement in the credit market are emerging. The flow of new loans has been
growing since the closing months of 2014; in March the twelve-month decline in bank
lending to firms was 2.2 per cent, a sharp abatement of the contraction that we have been
witnessing for three years. Italian banks' ample recourse to the targeted longer-term
refinancing operations and the start of government bond purchases by the Eurosystem
have permitted a significant reduction in the cost of bank funding and led to a gradual
improvement in that of credit. The interest rates on new loans to firms have come down by
more than a percentage point since the beginning of last year; the spread with respect to
German and French rates has more than halved compared with the peaks of two years
ago. In the course of 2014 the decline in interest rates, which until then had been confined
almost exclusively to exporting firms and larger companies, began to involve firms
operating on the domestic market and smaller enterprises.
Credit conditions nevertheless continue to be uneven. In the sectors of the economy where
economic prospects have already improved, lending to firms with sound finances has begun to
grow again. In those where recovery is proceeding more slowly, and especially in construction,
credit is still contracting.
In the first quarter of this year the loan quality and the profitability of the largest banking
groups showed signs of improvement, but the legacy of the recession still weighs on banks'
balance sheets. At the end of 2014 the stock of bad debts approached €200 billion, equal to
10 per cent of credit outstanding; other non-performing loans amounted to €150 billion,
7.7 per cent of loans. Before the crisis, in 2008, the overall ratio of non-performing loans was
6 per cent. Against these exposures banks have set aside substantial resources; they are
making write-downs which absorb most of their operating profit and crimp self-financing. The
upshot is a constraint on new lending.
The large stock of non-performing loans also reflects the very long and variable duration of
insolvency and credit recovery procedures, due in turn to the country's cumbersome civil
justice system. These widespread inefficiencies depress potential buyers' valuations of
impaired assets and discourage their sale on the market. The unfavourable tax treatment of
loan loss provisions, though mitigated, still does not allow their immediate deduction from
taxable income, as happens instead in the other main European countries; this determines
an accumulation of deferred tax assets. Measures are being drafted to eliminate these
competitive disadvantages, which weaken the Italian banking system.
The development of a secondary market in non-performing loans, which is practically
nonexistent at present, would contribute to fully reactivating the financing of households and
firms. For some time we have been proposing initiatives along these lines, with scope for
public-sector participation. We are working together with the Government to design them,
in compliance with the European rules on state aid. A discussion that we hope will be rapid
and constructive is now under way with the European authorities.
In 2014 the large inc