The The Governor's Governor's
Concluding Concluding Remarks Remarks
Annual Report
Rome, 31 May 2019
year
financial
125th
th
Year
125
2018
Financial
The Governor's
Concluding Remarks
Annual Report
2018 - 125th Financial Year
Rome, 31 May 2019

Ladies and Gentlemen,
The Bank of Italy contributes to the definition of monetary policy in the
euro area. It is the authority charged with safeguarding financial stability and
supervising intermediaries. It manages payment settlement systems, monitors
these systems and supervises the financial markets. It conducts economic,
legal, and statistical research and provides services to the public. It is perhaps
difficult to appreciate the sheer variety and breadth of everything the Bank
does, given the many essential tasks it carries out in the public interest. In
compliance with transparency requirements and legal obligations, the Bank
provides an account of its work in the Report on Operations and Activities
which, as is now customary, is published today together with the Annual
Report. We are increasingly committed to promoting economic and financial
knowledge and to communicating the results of our work.
The Bank's key functions are highlighted in our balance sheet, which
I already talked about on 29 March in an Address to the Ordinary General
Meeting of Shareholders. This also illustrated the Bank's capital reallocation,
a process which began in 2014 with the reform of the ownership structure,
leading to an expansion of the shareholder base. Finally, it presented the
results of the financial year for 2018, which recorded a net profit of €6.2
billion, €5.7 billion of which were allocated to the State, in addition to taxes
amounting to €1.2 billion.
Three of the five members of the Bank of Italy's Governing Board
completed their mandates this year. With the appointment of Fabio Panetta
as Senior Deputy Governor, the confirmation of Luigi Federico Signorini as
Deputy Governor and the designation of Alessandra Perrazzelli and Daniele
Franco to the same role, the board has been fully replenished.
Salvatore Rossi and Valeria Sannucci have retired from the Governing
Board. They both brought their talents and skills to several sensitive positions
within the Bank. The conclusion of his term as Senior Deputy Governor
of the Bank of Italy means that Salvatore has also come to the end of his
mandate as President of IVASS, which greatly benefited over the years from
his drive for innovation.
I am sure I speak for the Board of Directors in thanking them for their
work in the service of our country. Let me add to the gratitude of the entire
institution my own affectionate farewell to these two people I count as friends,
with whom I have worked very closely over the course of my career and with
whom I have shared the by no means light responsibility of managing the
Bank during these undoubtedly difficult years.
I would like to welcome Alessandra Perrazzelli, who has agreed to put
at the service of the general public her considerable experience and proven
ability in senior professional positions in Italy and abroad. I would like to
welcome back Daniele Franco, whose outstanding technical abilities, along
with his steady and balanced judgment, will be of great use to us over the
coming years.
The contribution of each and every member of the Governing Board is
crucial in guiding the Bank's operations. Yet nothing we do is or would be
possible without the commitment and professionalism of all our staff: hired
and promoted via rigorous, meritocratic procedures, immune to external
pressures, and united by that spirit of genuine dedication to public service of
which we are justly proud. Let me extend the heartfelt thanks of the Board of
Directors, the Governing Board, and express my own personal gratitude to all
the women and men working for the Bank.
The international outlook and the Italian economy
The system of supranational institutions and multilateral rules that has
supported integration and global economic growth since the end of the
Second World War has entered a very difficult phase. The trend towards
trade openness, which had grown stronger in recent decades, has come to an
end. The sharp deceleration in international trade observed in 2018 reflected
tensions linked above all to the new protectionist strategy pursued by the
United States (Figure 1).
A large share of intermediate goods is produced abroad, and by
increasing the cost of production factors, protectionist measures ultimately
rebound on domestic firms and magnify the effects of tariffs on consumers.
The repercussions on production are not confined to those caused directly
by trade barriers, but also stem from the deterioration of firms' confidence,
the downward revision of investment plans, and the greater volatility of
international financial markets.
The International Monetary Fund predicts that global growth will fall
to 3.3 per cent this year, the lowest figure since the contraction of 2009. The
weaker conditions are widespread and affect areas accounting for over 70
per cent of the global economy. The projections point to a recovery starting
in the second half of this year, boosted by expansionary economic policies
in the main countries and by the ensuing improvement in financial market
conditions. There are still significant risks, however, including geopolitical
ones.
The slowdown is mainly affecting the economy of the euro area, which is
more open to international trade than the United States or Japan. Reliance on
foreign demand is particularly high in Germany, the most vulnerable country
from this point of view, but also in France, Italy and Spain, countries that are
all closely integrated into global value chains, including intra-European ones.
The marked decline in business confidence is curbing investment (Figure 2),
and in the second half of 2018 the downturn in the automobile industry
contributed to the worsening of the macroeconomic situation.
The growth projections for the euro area have been steadily revised
downwards. According to the main international institutions, GDP growth
will be just over 1.0 per cent this year and around 1.5 per cent in 2020:
the risk of this trend being less favourable is not negligible. The weakness
of production has affected both actual inflation and that expected by the
markets. At the same time, the ECB forecast a slower convergence in inflation
towards the objective of a level below, but close to, 2 per cent.
Last March the ECB's Governing Council announced that monetary
policy would remain expansionary for longer than had previously been
indicated. It expects that rates will stay at the current low levels at least until
the end of 2019 and, in any case, for as long it takes to achieve price stability.
The Eurosystem will continue to fully reinvest the resources obtained from the
redemptions of maturing securities held under the asset purchase programme
for an extended period of time. From next September there will be a new
series of targeted longer-term refinancing operations to maintain favourable
conditions on the credit market and the orderly transmission of monetary
policy. The Governing Council reiterated that it stands ready to adjust all the
available instruments to guarantee convergence towards the inflation aim.
In the second half of 2018, GDP declined slightly in Italy. For the year
as a whole, the rate of growth was 0.9 per cent, just under half that of 2017.
Negative contributions came from the slowdown in output in Germany and
greater uncertainty, which in turn was affected by the heightened tensions
surrounding government securities. This led to a sharp downsizing of firms'
investment plans. Household spending also slowed, reflecting the deterioration
of the economic outlook and sluggish employment rates since the summer.
Permanent employment contracts in the private sector turned upward
again, boosted by the conversion of fixed-term contracts. These were affected
in the second half of the year by the limits introduced by the 'Dignity Decree'
which, together with the worsening economic situation, are nevertheless
reducing the probability of remaining employed at the end of a fixed-term
contract.
In 2018, inflation stood at 1.2 per cent and the core component, net of
food and energy products, remained below 1 per cent. The pace of growth in
prices remained lower than in the euro area; the weakening of the economy
weighed on labour costs and firms' profit margins.
Even though GDP recorded a slight increase in the first quarter, there is
widespread consensus regarding the forecasts for much lower growth this year
than the already subdued growth of 2018. To return to higher investment
rates and more robust spending on consumption, trade tensions must subside,
global financial market conditions must remain favourable and above all, the
confidence of firms and households must rise again.
According to official estimates, the introduction of a new basic income
scheme (reddito di cittadinanza) and new pension measures, without taking
account of the restrictive effects of covering the cost, would lead to an increase
in GDP of about 0.6 percentage points over the three-year period 2019-21.
This assessment appears reasonable if we assume that all the funds allocated
are spent. By contrast, the assessment of the effects on employment, which is
expected to be half a percentage point higher in 2021, displays ample margins
of uncertainty.
The tensions in Italy's government bond market are curbing growth
prospects. The yield on ten-year government bonds is almost one percentage
point higher than the levels recorded in April of last year. The spread with
respect to the equivalent German bond has increased by 160 to around 280
basis points, while it has risen by 140 to 190 basis points with respect to
Spanish bonds (Figure 3). The premiums on credit default swaps indicate that
both credit risk and the risk of the debt being redenominated in a currency
other than the euro continue to push the yields on Italian government bonds
upwards; these risks are closely interlinked and in times of tension could rise
sharply in market assessments.
The pass-through of the greater cost of public sector securities to that
of bank loans to firms and households has been modest so far, thanks to the
ample liquidity and the improved balance-sheet conditions of intermediaries.
Nevertheless, signs of tension are beginning to emerge: surveys indicate
that credit supply policies, though remaining relaxed overall, are gradually
tightening, especially for small firms; this is due to both the deterioration in
the macroeconomic outlook and to higher bank funding costs. It is estimated
that, other things being equal, and discounting negative effects on firms' and
households' confidence, an increase of 100 basis points in the yields on public
sector bonds would lead to a reduction of 0.7 per cent in GDP over three
years.
As acknowledged in the Economic and Financial Document (DEF),
the cyclical slowdown is increasing the budget deficit in the current year.
The increase in the debt-to-GDP ratio could exceed that indicated in the
government's budget (almost half a percentage point), which assumes revenue
from privatizations amounting to about €18 billion (one percentage point of
GDP).
The structural difficulties of the Italian economy
Our country has a number of strengths it can draw on to support
economic activity in unfavourable conditions. In this decade, goods exports
have kept pace with foreign demand, interrupting the protracted decline in
Italy's share of the global market. The current account balance turned positive
again in 2013 and for three years now the surplus has stood at around 2.5
per cent of GDP; the net international investment position is practically in
balance. Italy's ability to compete on the international markets has benefited
from the reallocation of exports towards forms of production which are less
exposed to the pressures of emerging economies and made by more efficient
and larger firms.
At the end of last year, household debt was equal to 41 per cent of GDP,
as against 61 per cent in the other euro-area countries as a whole; the value
of savings, of which more than 60 per cent in real estate, was more than eight
times that of income, compared with an estimated seven times for the rest of
the area. Firms' debt is also low: equal to 69 per cent of GDP, against 112 per
cent in the other countries.
Overall, however, the economy has been struggling to pick up since
the double-dip recession. GDP is still more than 4 percentage points below
what it was in 2007, and 7 percentage points in per capita terms. Though it
has regained the 2007 level of 59 per cent, the employment rate is 9 points
below the euro-area average. The development gap has increased in the South
of Italy, where more than 18 per cent of the labour force is unemployed,
compared with 7 per cent in the Centre and North; the gap is 4 percentage
points higher than it was in 2007.
The problem is not merely low aggregate demand. In the decade preceding
the crisis, Italy also lagged behind the other euro-area countries by around
one percentage point per year (Figure 4). Despite the measures enacted,
our economy's capacity to grow and to achieve high employment rates is
weighed down by the unsatisfactory quality of public services, inadequate
infrastructure, low levels of competition and the distortions associated with
widespread tax evasion and corruption, not to mention the obstacles posed by
organized crime. The result is an economic climate that is little predisposed to
business and its growth, to investment and to employment.
To confine ourselves to seeking temporary relief by raising the public
deficit could prove less than effective, even counterproductive, if this led to
a deterioration in financial conditions and in the confidence of households
and firms. The risk of a 'restrictive expansion' must not be underestimated;
the expansionary effects of a budget can be more than offset by the restrictive
ones of higher financing costs for the State and the economy.
The high debt-to-GDP ratio continues to be a severe constraint; to lessen
it, there must be no delay in defining a rigorous and credible strategy for its
reduction in the medium term. Compared with the rest of the euro area,
the cost of Italy's public debt is higher and its economic growth lower. Aside
from Greece, on average in the last four years Italy is the only other country
to report a large and positive gap between these two variables; at 1 percentage
point, this gap has in turn pushed up debt-to-GDP ratio by around 1.3
points per year. In the same period, GDP growth was 0.3 percentage points
higher than the average cost of the debt in France, 1.0 points higher than that
in Spain. When the gap between the cost of the debt and economic growth
is positive, what is needed, if only to stabilize the debt, is a primary surplus
(when revenues exceed expenditure net of interest expense). The larger the
gap, the bigger the surplus required.
The increase of 1 percentage point recorded in the average yields at issue
of Italian government securities in 2018 followed a decline of around 3 points
between 2012 and 2017. The risk of this leading to a further widening of the
gap between the cost of the debt and the GDP growth rate must be countered
(Figure 5). Only careful budgetary control and solid prospects for a return to
higher economic growth rates can boost confidence in the government bond
market and bring yields down towards the levels prevailing in the rest of the
euro area.
Ensuring that the budget can contribute to a lasting increase in GDP
growth calls for incisive interventions in the composition of expenditure and
revenue. Greater prominence should be given to programmes better able to
stimulate economic activity, as opposed to subsidies and transfers. This must
be accompanied by measures designed to limit the distortions introduced by
taxation, especially in the labour market, and to step up the fight against tax
evasion. Increases in public expenditure or lower revenues must, however,
be part of a framework that guarantees financial sustainability and specifies
objectives, priorities and sources of funding.
Public investment expenditure amounts to about 2 per cent of GDP, one
third lower than it was at the start of this decade. The objective of recouping
half of the lost ground in three years, with planned increases in spending in
the order of 10 per cent per year, assumes a big improvement in the ability
to move from identifying what needs to be done to actually getting it done.
But it is not enough to simply spend more; resources must be utilized more
effectively, by improving the procedures for selecting, assigning and executing
the works. By international standards, Italy is behind both in terms of works
completed and money spent.
A primary surplus of under 0.5 per cent, such as would be obtained
in 2020 if the VAT increases under the safeguard clauses envisaged in
current legislation were deactivated without any countermeasures, would be
incompatible with a reduction in the debt-to-GDP ratio; it would have adverse
effects on the risk premiums on public sector securities and, subsequently, on
economic activity. Making the deactivation of the VAT clauses conditional
on the identification of compensatory measures, as the Economic and
Financial Document (DEF) does, reflects these concerns. All the possible
options call for a careful and transparent evaluation of the potential effects on
demand, economic activity and income distribution.
Looking ahead, what Italy needs is a broad-based tax reform. Since the
early 1970s, new forms of taxation have been introduced and a complex set of
concessions and exemptions progressively put in place, with no comprehensive
plan and, not infrequently, with unclear guidance. Reforming only some
concessions or restructuring just one tax means continuing this process of
stratification. Instead, this must stop, and a stable framework erected that
gives certainty to producers and consumers, investors and savers, with
measures that reward workers and are pro-business. Account must also be
taken of how the various components of the taxation system interact: indirect
taxation with forms of low-income support; direct taxation with detractions
and deductions; income support with employment incentives; interactions
between the various exceptions to the general taxation regime envisaged for
each taxable base; and between these components and the fight against tax
evasion, taking full advantage of all the available technologies.
Italy is a country with a rapidly ageing and shrinking population. While
these trends are common to many EU countries, they are more evident here.
The medium scenario projection published by Eurostat shows that in the
next 25 years, the share of the population aged at least 65 will reach 28
per cent in the European Union as a whole and 33 per cent in Italy; the
financial pressures on pensions and long-term care will increase as a result.
The population aged between 20 and 64 will fall by 6 million in our country,
notwithstanding a hypothetical net influx from abroad of 4 million persons
in this age group (Figure 6). The reduction in production capacity linked to
demographic trends must be countered with sharp increases in the labour
market participation rate and in productivity.
The participation rate is still 8 percentage points below the European
average, despite having risen in the last 20 years, from 61 to 66 per cent. As
in the other countries, the main contribution has come from older workers,
linked to changes made to the pension system. The female participation rate
has also risen, from 47 to 56 per cent. The increase has nonetheless been less
marked than that recorded in the rest of the EU and the male participation
rate is still 19 points higher than that of women, one of the largest gaps
in Europe. This suggests that there is much potential for increasing labour
force participation and highlights the need to act decisively to identify and
introduce measures, services and incentives designed to raise the female
participation rate.
Immigration can help to boost Italy's production capacity, but the
difficulties encountered in attracting high-skilled workers and in integrating
and training those who come from abroad. Since the early 1990s, the number
of immigrants arriving in Italy has surpassed that of emigrants every year.
After falling slightly during the sovereign debt crisis, net immigration has
continued to rise, reaching almost 190,000 people in 2018 or 0.3 per cent of
the population. The share of foreigners who hold degrees, equal to almost 13
per cent, is less than half the EU average. Productivity and entrepreneurial
skills are also being adversely affected by the gradual increase in the number
of young people and university graduates leaving Italy every year, reflecting
structural lags in the economy. In the space of ten years, youth emigration
increased fivefold to reach 0.5 per cent in 2017, while at 0.4 per cent, graduate
emigration more than doubled.
Italy has been slow to respond to the technological revolution (Figure 7)
and economic growth has been badly hit as a result. The sectors comprising
the digital economy today contribute 5 per cent of total value added, against
8 per cent in Germany and 6.6 per cent on average in the European Union.
Since the outbreak of the sovereign debt crisis, the relative weight of these
sectors has declined in Italy, going against the trend in terms of the European
average. But we must invest in advanced and green technologies for the
very sustainability of economic and social development, and to preserve
environmental balance.
The gap with respect to the rest of the EU concerns almost all sectors
where firms can adopt innovative technologies; in the automation of
production processes it is very apparent in countries that have the kind of
sectoral specialization Italy has, such as Germany. The development of new
generation telecommunications networks remains limited. The role of central
government in promoting the introduction of new technologies is similarly
modest; the European Commission's Digital Economy and Society Index
(DESI) ranks Italy 19th for digital public services.
One of the factors that has slowed the advent of the digital economy
has been Italy's fragmented production structure, mainly comprising small
firms, whose ownership and management arrangements often overlap, and
which are little inclined to accept external injections of capital, technology
and expertise. In 2017, fewer than one fifth of firms with between 20 and 49
workers had adopted at least one advanced technology (such as robotics and
artificial intelligence); this share rises to one third among medium-sized firms
and is more than half for those with 250 or more workers. The more complex
the technologies considered, the wider the gap between small and large firms.
The fragmentation of the productive sector has had a negative effect on
firms' capacity to innovate: expenditure on research and development in the
private sector amounted to 0.8 per cent of GDP in 2017, less than half the
average in OECD countries. It is low in the public sector too (0.5 against 0.7
per cent). At just below 1 per cent of GDP, the share of resources devoted to
the university system is roughly one third below the OECD average.
In recent years, incentives have been introduced to support investment,
research and development, and innovative start-ups. These measures have
proved effective overall. Some of these incentives were confirmed in the latest
budget law or in last April's 'Growth Decree', recalibrated mostly in favour
of small and medium-sized firms. To be effective, industrial policy requires a
stable legislative framework that facilitates change in the economy as a whole.
Low investment in innovation has been accompanied by the
comparatively poor acquisition of knowledge and skills by Italian students
and adults; these delays feed into one another, in a vicious cycle that must
be reversed. Investments in training that accompany individuals throughout
their working lives are also necessary to prevent the risk that the adoption
of new technologies, with the attendant drop in demand for the workers
most affected by the advent of automation and digitalization, will magnify
inequalities of income and opportunity, and reduce employment.
Italy's difficulties are amplified in the South and Islands, harder hit by
the double-dip recession than the rest of the country. First and foremost,
the business climate in the South needs to improve, especially in relation to
guaranteeing legality. The technological gap to be bridged is even wider: the
share of value added ascribable to the digital economy, at close to 2.5 per cent,
is more than 3 points below that of the Centre and North. The skills gap must
be narrowed, public policies made more effective, and the quality of local
government and infrastructures improved: 70 per cent of 'unfinished works'
are located in these regions, of which only 30 per cent are public works.
Roughly one third of Italy's population lives in the South of Italy, which
generates almost one quarter of the country's GDP. The southern regions are
becoming poorer still now, owing to the emigration of their youngest and
most highly-educated people, mostly to the Centre and North of Italy. In the
last ten years, net migration has been barely positive overall, but there has
been a large net outflow of young university graduates. It is a trend that has
immediate social costs and impacts negatively on the prospects for growth.
Over the years there have been numerous attempts to deal with the
economic difficulties of the South, with very different interventions whose
results, on the whole, have been disappointing. Support measures can
contribute to growth in the regions that lag behind; they must not, however,
distort the incentives for firms and workers by hindering the optimal use
of resources. To improve the economic conditions in the South and Islands
and to raise growth potential requires long-term action, fully exploiting
the opportunities afforded by European and national funds. It is necessary
to intervene in the factors underlying the delays in the South; attempts to
compensate for them with monetary transfers cannot be the only solution.
The effects on the southern economy of public investment in schools and
infrastructure could be highly significant.
Banks, finance and supervision
Even though banks' balance sheets continued to strengthen in 2018,
the effects of the crisis have not yet been fully reabsorbed and are delaying
their response to the profound changes in the industry's market structure,
customers' habits, financial regulations and technology. As in the rest of the
euro area, profitability, though recovering, remains low and the incidence of
operating costs is still high; these trends are reflected in banks' share prices.
Some medium-sized banks are still experiencing difficulties, which are being
dealt with by the Italian and European supervisory authorities and by the
government. Solutions are being actively sought to relaunch banks and to
protect those involved.
The outlook for banks is still closely linked to the performance of the
economy and to the perception of country risk, which affect asset quality
and the costs they incur in raising funds on the markets. For the entire
banking system, capital ratios, which in mid-2018 were affected by tensions
on government bonds, are recovering; at the end of 2018 the CET1 ratio of
banks directly supervised by the ECB stood at 12.7 per cent of risk-weighted
assets, against an average of 14.3 per cent for significant euro-area banks.
Adverse cyclical developments would inevitably affect balance sheets again, so
the need remains for continued decisive action to reduce costs and improve
profitability.
In Europe the use of digital channels in banking intermediation is in
constant growth. Over the last decade, the share of customers using the
Internet to access their current accounts has almost doubled (Figure 8) and
the number of branches has been reduced by about one quarter. The spread
of more complex technologies (FinTech) is rapidly transforming the structure
of the financial industry. The management and analysis of big data, the use
of artificial intelligence and machine learning, and the potential offered by
distributed ledger technologies are changing the services provided; they are
also opening the sector to new competitors - including, but not only, the
Big Techs - that are able to swiftly exploit the advantages of operating in
the digital economy and trade. Market estimates indicate that investment
in financial innovation, mainly attributable to large technological firms and
start-ups, has increased sixfold at global level in the last five years; in 2018 it
exceeded $100 billion, one third of which in Europe, but it is still modest in
Italy.
Italy's banks are providing more and more traditional services online,
in order to increase organizational and operational efficiencies. Almost all
banks now permit payments to be made using mobile devices, often for small
amounts; over half of them place savings products through digital channels;
though on the increase, the number of banks offering loans through portals
is still modest (Figure 9). Nevertheless, the delay in responding to the
challenges posed by the use of more complex technologies risks the gradual
erosion of market shares. According to our surveys, half of the banks have yet
to launch or even plan to launch trials in this field, for instance in the use of
new instruments for assessing creditworthiness. A relatively limited amount
of resources are allocated to these projects and are concentrated among the
larger banks.
Using technology to provide customized services with greater value
added can generate tangible benefits in terms of reducing costs, broadening
consumer choice and increasing profitability. The smaller banks, for whom
investment at individual level is too costly, can enter joint initiatives for the
outsourcing of services designed to promote their products. The spread of
new technologies, however, also carries new risks, especially regarding cyber
security and customer data protection; IT projects require particular care and
advance planning.
The Bank of Italy is also experimenting with the use of new technologies
in its supervisory activity. Recourse to artificial intelligence is not confined
to seeking improvements in forecasting economic and financial variables; it
is also useful for analysing the level of investors' trust in banks and it boosts
the effectiveness of anti-money laundering activities. The Bank has long been
in contact with market operators offering innovative solutions: since 2017
we have had an innovation hub, 'FinTech Channel', on our website. This
direct interface with operators in a digital environment makes it possible, by
means of advance knowledge of new projects, to assess their compliance with
legislation, identify potential problems and consider changes to the rules and
procedures applied at national level.
The importance of preventing and controlling cyber risks is bound
to grow in an increasingly digitalized and interconnected system in which
outsourcing is on the rise. The computer emergency readiness team for the
financial sector (CERTFin), presided over by the Bank of Italy and the Italian
Banking Association, whose members also comprise other sectoral authorities
and most financial and technological operators, facilitates the exchange of
information during cyber attacks, supports operators in the event of security
breaches and helps to improve the effectiveness of firewalls. We play an active
part in international cooperation initiatives - especially in the Financial
Stability Board, the Bank for International Settlements and the G7 - to
define common standards and lines of action to limit cyber risks at national
and global level.
Bank credit quality continues to improve (Figure 10). Thanks in part to
the improved economic situation in recent years, the new non-performing
loan rate has fallen below the levels observed before the global financial
crisis; in the first quarter of this year it was equal to 1.3 per cent. The
stock of non-performing loans declined considerably, especially as a
result of some major sales, totalling €26 billion in 2016, €42 billion in
2017 and €55 billion in 2018. Driven by pressure from the supervisory
authorities, the increase in sales also benefited from banks' progress in
providing detailed information on the cha