Speech by the Governor of the Bank of Italy
Ignazio Visco

Economic developments
Economic activity in Italy has been virtually stagnant since the early months of
2018, in part owing to the slowdown recorded at European and global level. The latest
cyclical indicators have provided conflicting signals. Our business surveys continue to
point to expectations of an expansion in demand. Conditions on the financial and credit
markets have improved, and investors' confidence has risen, as shown by the sizeable
purchases of public sector securities made by non-residents and the considerable
reduction in their yields, and the significant narrowing in the ten-year spread with the
German Bund. However, Istat's preliminary estimate indicates that GDP declined
by 0.3 per cent in the fourth quarter of last year, in part likely reflecting especially
unfavourable developments in the most erratic components of final demand.
Our projections reported in the most recent Economic Bulletin, which were
formulated before the release of Istat's preliminary estimate, suggest that GDP
growth will still be very low this year, after remaining virtually unchanged in
2019, but will be higher in the next two years. This scenario is subject to significant
downside risks. Much will depend on the performance of the global economy and
of our main European trading partners. International trade disputes have abated but
geopolitical tensions have risen, though with limited repercussions on oil prices so
far. The terms of the future economic relations between the European Union and
the United Kingdom, which formally left the Union on 31 January, still have to
be worked out during the transition period that will last until the end of the year.
An additional risk factor has emerged in the form of the possible repercussions of
the spread of the new coronavirus, especially for the Chinese economy, which in
recent years has been one of the main drivers of world growth.
On the domestic front, for the time being the financial markets are benefiting
from diminished political uncertainty. However, it has still not been possible to
defeat the chronic vulnerability connected with the medium-term prospects of the
public finances and of economic growth. The yield spread between Italian ten-year
public sector securities and the corresponding German securities, which is now
below 140 basis points, remains almost double the spread recorded for the public
sector securities of countries such as Spain and Portugal, which were also hit hard
by the global financial crisis and the euro-area sovereign debt crisis.
The situation is still affected by the unknowns regarding the implementation
of, and possible alternatives to, the increases in indirect taxation provided for
by the safeguard clauses in 2021 and 2022 (equal to 1.1 and 1.4 per cent of
GDP respectively) and by ongoing concerns about certain trends in our current
expenditure. These are compounded by signs of disaffection with the European
project and pessimistic assessments of the growth potential of our economy
that assume a lack of ability to make the reforms needed to unlock the country's
productive resources. These perceptions must be countered by making the economic
environment more conducive to business and innovation, by reducing uncertainty,
including around regulation, which acts as a brake on private investment, by
grounding changes in taxation in a holistic vision for the tax system, and by
implementing in full the government's public sector investment plan.
Slow and fragile economic growth in the euro area continues to affect inflation,
which remains well below 2 per cent. In January, price growth increased slightly (to
1.4 per cent), but the core component decreased (to 1.1 per cent, and to 0.5 per cent
in Italy) and inflation expectations - not only for the short term - are at very low
levels. The ECB Governing Council remains convinced of the need to maintain for a
prolonged period of time the current expansionary stance reinforced last September
and confirmed in full at its January meeting.
The transmission mechanism of monetary policy continues to be effective in
supporting investment and consumption. The reduction in the deposit facility rate
was passed on to short-term market interest rates and the recovery in the net purchases
of financial assets exerted renewed downward pressure on long-term rates. The
introduction of a two-tier system for the remuneration of banks' reserves in excess of
the minimum requirement, which took place without generating tensions, is intended
to preserve banks' ability to provide credit to firms and households.
An increase in aggregate demand - by supporting labour market conditions,
which are still uneven between euro-area countries, and by strengthening wage
growth - could facilitate a rise in inflation towards levels consistent with the price
stability objective. However, greater support from the other economic policies
remains essential to sustain growth in the euro area and to avoid the perpetuation of
the extraordinarily low level of market yields, which reflects above all insufficient
demand for investment compared with the supply of savings.
The Governing Council has launched a review of its monetary policy strategy.
As announced, this will be based on a thorough analysis and an open-minded
approach. It will have to assess whether there are aspects that require an adjustment,
given that, in a context of profound structural change in the world and in the euro
area, the challenges connected with the current low inflation levels are different from
those historically posed by high inflation.
Banks, non-bank intermediaries and market infrastructures
In the banking sector, the quality of credit continues to improve. Notwithstanding
the weakness of the economy, the flow of new non-performing loans remains low.
Net of loan loss provisions, last September the ratio of non-performing loans to total
loans averaged 3.7 per cent, against 9.8 per cent at the end of 2015. Actions to reduce
the volume of non-performing exposures and to improve their management must
continue, above all by smaller banks that tend to have relatively higher NPL ratios
and lower coverage ratios compared with those of the largest groups.
Market conditions have improved in recent months and banks have reduced
the quantity of government securities on their balance sheets. At the end of
December, excluding securities held by Cassa Depositi e Prestiti SpA, these
holdings amounted to €313 billion or 9.8 per cent of total assets; in early 2015,
they peaked at €403 billion. Notably, since last May, intermediaries have made net
disposals of almost €40 billion worth of government securities. The role of banks
as contrarian investors has been confirmed.
In the first nine months of 2019, profitability rose compared with the same
period in the previous year. Net of extraordinary components, ROE increased on
average from 5.8 to 6.6 per cent, although it is still lower than the cost of equity.
The capital base continues to strengthen: in September, the CET1 ratio averaged
13.6 per cent, compared with 13.3 per cent at the end of 2018.
Nowadays the traditional banking model offers low returns, for reasons
not only linked to cyclical economic developments. Small and medium-sized
banks are the most affected and struggle to strengthen their balance sheets
owing to high costs and difficulties in gaining access to the capital market;
significant economies of scale and scope are needed to successfully fund the real
economy. Intermediaries specializing in asset management tend to fare better,
as do those distributing financial products through a network of salespeople or
those operating primarily in the leasing, factoring and consumer credit sectors.
The cost-to-income ratio of the small traditional banks, equal to 72 per cent on
average, is higher than that of both the large significant groups (66 per cent) and
of the specialized intermediaries (64 per cent).
For all intermediaries, the process of restructuring and adapting to the new
economic, regulatory and market landscapes, as well as to technological advances,
must proceed with determination. Stronger balance sheets and greater efficiency can
be achieved if the industry is reshaped in various ways, in terms of size, ownership
structures and business models. As I have often pointed out, initiatives to expand the
scale of operations of small banks such as mergers or greater integration of business
areas across banks can prove beneficial to the extent that they reduce cost ratios,
increase and diversify earnings, and enhance banks' ability to compete on the market.
The reform of the mutual banks (BCCs) was designed to achieve the necessary
efficiency gains and economies of scale to meet the challenges associated with
the transformation of the banking sector, whilst preserving these banks' original
mutualistic spirit. The establishment of two new mutual banking groups brings
the number of groups now operating in Italy to 54, comprising 310 banks, while
there are 100 stand-alone banks. At the end of 2008, there were 81 groups and
499 stand-alone banks. The two new groups, which this year will be subject to
the ECB's comprehensive assessment, must take swift action to cut costs and
rationalize their distribution network by tackling the cases of individual BCCs
in difficulty.
The financial conditions of the mutual banking groups, their operating
model, organizational arrangements and governance must ensure their long-term
sustainability. The Single Supervisory Mechanism does not expect these banks to
achieve the same profitability as the other intermediaries, but it must be sufficient
to maintain adequate capital levels, which are indispensable to continue carrying
out their work of funding the economy effectively.
Households' financial assets amount to around €4.4 trillion, two and a half
times GDP, a considerable sum by comparison with the countries of mainland
Europe, though still below that recorded in the United Kingdom and the United
States. Around one third of household wealth is held in cash and deposits, one
third in managed assets, and one third is invested directly in shares and bonds,
both public and private, and in other assets. The share of cash and deposits, which
had declined to 23 per cent in 2000, has gradually increased, reflecting the fall in
market rates and the uncertain economic outlook. In the same period, the share
of managed assets, which offer instruments that enable a greater degree of risk
diversification than that typically offered by direct investment in the markets,
recorded a comparable increase.
The portion of household financial assets entrusted to asset management
institutions is nonetheless still 10 percentage points below the euro-area average
and the share for the United States, and some 30 points lower than in the United
Kingdom, something that the greater role of public pensions in Italy goes some
way to account for. In Italy, around 11 per cent of households' financial assets are
in investment funds, 18 per cent in insurance policies, and 2.5 per cent in pension
products.
In recent years, the sector has benefited from new regulation. Long-term
individual savings plans were introduced by the 2017 budget law and have
encouraged households to put their money into investment funds specialized in
Italian corporate equity and debt instruments. The first European Long-Term
Investment Funds (ELTIFs) have been created. These closed-end funds are
dedicated to both professional and retail investors, which invest in both equity and
debt instruments.
Investment in funds specialized in securities issued by non-financial
companies, such as private equity and venture capital funds, remains low by
international standards. In the past few years, however, there has been growing
investor appetite for this sector: since 2016, the Bank of Italy has authorized the
establishment of approximately 70 asset management companies (SGRs) and
closed-end investment companies (SICAFs), most of which invest in these assets.
The Bank of Italy is responsible for the prudential supervision of most of
the components of the non-bank financial system. Specific provisions regulate
the activities of asset management companies (SGRs and SICAFs), securities
investment firms (SIMs), financial intermediaries included in the Single Register
provided for in the Consolidated Law on Banking ('financial companies'), and
payment service providers such as payment institutions (PIs) and electronic money
institutions (EMIs). In addition to the companies belonging to the major banking
and insurance groups, numerous entities are controlled by industrial groups and
private equity funds, and by various intermediaries of a public nature or with a
strong public profile (regional finance companies, infrastructural or strategic
funds). At the end of last year, there were 159 SGRs operating in Italy, together
with 32 SICAFs, 69 SIMs, 202 financial companies and 48 PI or EMI payment
service providers.
The Bank of Italy's supervisory activities, which it carries out in tandem
with its branches, aim to strengthen intermediaries' organizational and corporate
governance arrangements and internal risk-control systems; the Bank also
intervenes in cases of difficulty, requiring financial and balance-sheet restructuring
and other strategic and organizational changes. In the most serious cases, the Bank
imposes supervisory sanctions and issues restrictive measures, and can even adopt
special measures. When managing a crisis, the objective is to prevent disorderly
market exits that could have serious repercussions on investors and counterparties.
We do not, and cannot, supervise those who offer financial services illegally,
without requesting authorizations and by breaking the rules. However, the Bank's
website contains a section with lists of both authorized intermediaries and also of
those taken off the list and those found to have operated illegally. There is constant
interaction with the authorities and institutions that combat illegal practices and
counter the distribution of financial instruments designed solely to evade regulation,
including in ways that exploit the opportunities provided by new technologies.
The proper functioning of the financial system also depends on the legal and
technical-operational efficacy and robustness of its infrastructures, which include
trading platforms, central counterparties, and securities settlement systems. The
organizational choices and business models of these operators influence the
conditions of access, ease of placements, and efficiency and liquidity of trading.
The companies that manage Italy's financial market infrastructures (Borsa
Italiana, MTS, Cassa di Compensazione e Garanzia, and Monte Titoli) belong to a
group that is controlled by the London Stock Exchange, now situated outside of the
European Union. This group is the subject of a major acquisition - whose completion
is expected in the second half of this year - which will extend its sphere of activity
to include the provision and analysis of financial data. The new group will be among
the leading operators in the sector at global level. In exercising the prerogatives
assigned to them by law, the Italian authorities are closely monitoring each step of
the acquisition. Its implications for the subsidiary companies, in terms of governance,
organizational arrangements, financial equilibriums and strategic guidelines, must
not endanger the safeguarding of objectives of general public interest.
Challenges for intermediaries
Italy's financial sector must continue to face up to the challenges linked with
the changes in the macroeconomic context, the regulations and technology, as well
as those stemming from climate change. The variety in terms of business models,
scales of operation and legal forms may play a useful part in the functioning of the
banking industry, but it must be made compatible with these changes and with the
basic conditions for the sound and prudent management of intermediaries.
As I have pointed out, low interest rates are mainly the result of underinvestment
compared with the supply of savings and, more generally speaking, of the
weakness in demand following unfavourable trends, both long term and cyclically.
In response to the cyclical trends, monetary policy aims to boost demand and avoid
triggering a downward spiral in economic activity. It is likely that we will have to
live with low yields for some time to come.
In Italy, the low yields have so far had practically no effect on financial
intermediaries. For banks, the negative impact on net interest income has been
offset by the favourable impact on the quantity and quality of credit, together
with an increase in fee income. The latter must always reflect the usefulness
and effectiveness of the services provided to customers rather than shortsighted
rent-seeking behaviour. Insurance companies have also been affected to a
limited extent by the low market rates; their adoption of prudent strategies in
the past for matching asset durations with those of liabilities limited the effect
on their balance sheets. In the longer term, they could counter risks through
a greater diversification of portfolio assets and by continuing to adapt their
commitments to policyholders to the new market environment.
As regards the changes in the regulations, intermediaries will have to make
an effort on various fronts, and plan capital needs and the necessary funding ahead
of time. As far as non-performing loans are concerned, a calendar provisioning
approach to writing down new loans classified as NPLs has been in force in the
European Union since last year; it flanks the plans to reduce NPL stocks that
banks must submit yearly to the supervisory authorities. By the end of this year,
some changes will have to be made that also aim to harmonize at European level
the thresholds for classifying loans as having gone into default if instalments are
overdue.
In a country like Italy, where credit recovery procedures are particularly lengthy,
the new European practices for NPLs have encouraged the rise of a non-banking
industry for managing them. This new sector must be efficient for the benefit of those
investing in it and of the banks. Care must be taken in the phases following the sales
and securitizations of bad loans. The professionalism, integrity and organizational
and capital strength of the servicers entrusted with these operations are essential. The
Bank of Italy recently started an in-depth analysis to evaluate servicers' performance
and to check the overall effectiveness of the current regulatory and supervisory
framework. In the case of sales of unlikely-to-pay loans, it is important to encourage
the recovery of firms in difficulty as much as possible. As I have already noted on
other occasions, benefits may accrue from interventions by operators specializing in
company restructuring (turnaround funds) that can provide new funding and specific
entrepreneurial skills.
The setting-up of buffers for liabilities that can absorb losses and recapitalize
intermediaries continues, as per the regulations on crisis management (minimum
requirements for own funds and eligible liabilities - MREL). Over the last few
weeks, several banks have placed a considerable amount of bonds at lower costs
than in the past, including subordinated bonds, taking advantage of the favourable
financial conditions. Through this process, we expect that bonds eligible as part
of minimum requirements will be held by investors that are able to fully evaluate
the risks, in line with the provisions of the regulations for the markets in financial
instruments (MiFID).
Over the next few months, the European Commission will present a proposal
for the transposition of the prudential standards adopted by the Basel Committee
at the end of 2017 (Final Basel III). The new rules, which include the setting of an
output floor on the capital requirements calculated using internal models prepared
by the banks, will gradually come into force in 2022 and will be fully in place
in 2027. In order to cope with the impact of applying these standards, which is
expected to be lower than the average estimated for European intermediaries
as a whole, Italian banks will need to be decisive and continue to seek better
organizational and cost-related conditions.
Although almost all intermediaries provide basic products and services using
digital channels, more can be done in the way of adopting new technologies. The
opportunities provided by the digital revolution to the financial industry are as much
for reducing costs as for investing the resulting savings in developing products and
services that meet customers' needs better. While fully observing the principles of
correct and transparent conduct, this commitment means that, above all, IT security
and the control of cyber risks will continue to be necessary; substantial investment is
still required to ensure this. Accordingly, adequate instruments and professionalism
must be acquired; joint initiatives may be useful here for smaller intermediaries.
Lastly, with reference to the impact of climate change, there is increasing
debate over how to adapt risk control and management practices to the exposure
of assets to extreme natural events, also with longer timeframes than now. Yet the
challenges posed by climate change may also prove to be significant opportunities.
A decisive acceleration in decarbonization policies, such as that heralded by the
European 'Green Deal', will foster the supply of 'sustainable' products, shown by
market surveys to be potentially in great demand.
Challenges for the supervisory and crisis management authorities
The regulatory and macroeconomic framework that has come into being over
the last decade has made finding solutions for the difficulties experienced by the
smaller banks a more arduous task. On the one hand, injections of fresh capital,
especially in less attractive local areas and markets, are hindered by structurally
lower profit margins than before, by the serious legacy of the crisis in the real
economy, and by governance mechanisms that are self-serving and lacking in
transparency. The response of intermediaries to these latter issues has been slow
and inadequate; the related legislative reform process has been difficult and has
encountered opposition. On the other hand, the rules existing today rightly put limits
on the use of public money for bailouts, though there is some room for flexibility,
which was exploited in Italy not without difficulties, when public confidence and
the stability of important parts of the banking system were considered to be at risk.
Supervision is intensive, including on the smaller banks. It is carried out using
the powers allocated to the supervisory authority and in full compliance with the
business nature of banking and with the provisions of the law, with no collusion
or 'dirigiste' intentions. As far as possible, it takes account of the economic and
market context in which intermediaries operate, as well as of the difficulties in
both the restructuring and recovery processes for banks and in managing crises.
As I have pointed out on more than one occasion, with the entry into force of the
new European regulatory framework and in the absence of investors interested in
purchase and assumption transactions, the only way forward in the event of a crisis
is a piecemeal liquidation, resulting in a loss of value and in contagion risks.
When dealing with difficult situations, the instruments that the law puts at the
disposal of the supervisory authorities are used with great care. The intensity of the
corrective measures imposed on intermediaries is strictly proportionate to how far
a bank's financial situation has deteriorated. The press is not aware of successful
interventions; most of the interventions are successful, but not all of them can be.
Recourse to special administration - the most intrusive of supervisory
interventions - occurs as soon as the seriousness of the situation so requires. Nowadays
this is an 'early intervention' measure: unlike in the past, when searching for possible
solutions was an essential part of the special administrators' work, this measure
can only be taken when there is a prospect of recovery; otherwise liquidation is
inevitable. This is a very fine line, and we are extremely careful as to how we tread it.
Experience shows that in most cases, special administration is an effective instrument
that can help relaunch an intermediary or avoid traumatic solutions for crises. Since
2007, around 80 intermediaries have been placed under special administration, more
than half of which have subsequently returned to business as usual. When liquidation
has been necessary, the support for purchase and assumption transactions provided
by deposit guarantee schemes has made an orderly exit from the market possible,
usually with no losses for current account holders and savers.
Preventive interventions by deposit guarantee funds to avoid the emergence
of crises have also been and continue to be an important tool for preserving
stability. European legislation explicitly provides for this type of intervention
and also establishes a wide range of safeguards to avoid using resources that
are compulsorily earmarked for covered deposits (up to the European ceiling of
€100,000), which would breach State aid rules. The private nature of Italian funds
is a further guarantee of a thorough and prudent assessment in compliance with the
least-cost test, according to which interventions other than reimbursing deposits
can only be implemented if the cost is lower for the funds than it would be in the
event of liquidation. In most cases, preventive intervention has made it possible to
manage difficult situations successfully.
We have underscored on more than one occasion that the European framework
for bank crisis management needs to be equipped with procedures that allow
an orderly exit from the market of intermediaries for which the activation of a
resolution is not justified by public interest. The specific reference here is to the
orderly liquidation adopted by the US Federal Deposit Insurance Corporation
(FDIC), which has dealt with the crises of over 500 intermediaries since 2008,
thereby averting risks to the overall stability of the banking system.
We regularly give an account in our Reports of our supervisory work and of
the measures we adopt in this sphere, as we do in other Bank of Italy publications, in
the testimonies made before Parliament, and in our public speeches and interviews.
We are committed to informing the public more clearly about both our powers and
the constraints on what we can do, and we are open to discussion and dialogue. We
are continually learning from experience, and we keep abreast of and adapt to the
changes taking place in the financial industry.
The events that have affected some banks in difficulty over the last few years
have brought the topic of the protection of consumers of banking and financial
products to the forefront of the debate. It is important that - alongside the legislative
action and the supervisory interventions to improve the quality of the information
given to customers on the features, costs and risks of the products being sold -
intermediaries prioritize the needs of customers when drawing up their placement
strategies. The quest for yields by investors and for financial resources by small
and medium-sized firms is leading to a wider range of investment instruments that
also target non-professional investors, who need to be made fully aware of the
higher risks they carry, including their cost structures.
The rules in force today identify different responsibilities for the various
supervisory authorities. The Bank of Italy is in charge of customer protection
for banking and payment products and services, Consob is responsible for this in
investment services, IVASS covers the insurance sector, and the Antitrust Authority
is responsible for consumer protection in general. The closeness of the functions
and powers of the various authorities requires us to strengthen cooperation and
exchanges of information. This is essential in a context in which the characteristics
of financial instruments tend to change rapidly and their very nature can be
difficult to classify, making the precise definition of rules and spheres of control a
complex process. We must move beyond the view that sees prudential supervision
and conduct supervision as antithetical objectives: providing quality services and
maintaining good relations with customers are key factors to strengthening trust in
intermediaries and hence their competitiveness, profitability and solidity. This is a
clear lesson we have learnt from the experience of these recent and difficult years.
The supervisory action carried out by the authorities must be accompanied by
measures to improve the public's financial literacy. To a certain extent, this issue
is common to all the advanced countries, in which the multiplication of financial
products and investors' search for yield collide with the sometimes very limited
knowledge of financial mechanisms and concepts. The problem is more acute in
Italy. According to the latest survey conducted by the Bank of Italy in 2017 based
on the methodology developed by the OECD/INFE, only one third of the adult
population possesses a sufficiently high level of basic knowledge, compared with
half on average for G20 countries (and two thirds for OECD countries).
Since 2014, a Bank of Italy directorate has been in charge of customer
protection with the objective of strengthening the Bank's analyses and interventions
on supervised intermediaries in areas such as transparency and fair conduct, usury,
money laundering, combating the financing of terrorism, and in stepping up initiatives
to increase financial education for the general public; these initiatives have involved
more than 600,000 students over the last few years. Thanks to the contribution of our
branches, we have improved our management of complaints - we processed more
than 10,000 of them last year alone. The support provided by the technical secretariats
to the seven panels of the Banking and Financial Ombudsman made it possible to
look into more than 27,000 appeals in 2019, of which 15,000 ended with decisions
in favour of the customer. The Bank of Italy attaches the utmost importance to these
tasks. We are determined to commit all the resources necessary for these tasks and
we will continue to step up these activities, including by making changes to our
organizational structure in the coming months.
* * *
The challenges I have described and the commitments that stem from them
concern each and every one of us. Supervisory authorities must facilitate and
accompany the financial system's adaptation to the new economic and regulatory
environment and to technological advances and climate change. In Europe, we must
complete the banking union, above all by providing adequate instruments for an
orderly management of crises applicable to all intermediaries; a road map must be
laid down for the introduction of a genuinely common deposit insurance scheme.
Initiatives that could have procyclical effects or jeopardize financial stability must
be avoided. As I have observed on previous occasions, to complete the Economic
and Monetary Union and make the Eurosystem's action more effective, greater
integration in the capital markets and a pan-European fiscal policy are also needed.
A decisive role in achieving these objectives could be played by the introduction of a
common risk-free debt security, as is the case in the other major advanced economies.
In Italy, intermediaries must be resolute in upgrading their governance
structure, their technological assets, and their business models. They must
pursue levels of efficiency and profitability that can guarantee their ability to
attract capital from the market and support economic activity. However, neither
intermediaries nor central banks alone can create growth. In order to achieve a
higher path of stable expansion, economic policies are needed that look beyond
the one-year horizon of the government budget. Setting out a systematic reform
framework encompassing all the individual measures can in itself provide an
expansionary boost by reducing the trust deficit, which weighs on government
bond yields and private enterprise even more than the public finance deficit does.
A return to enduring growth must be pursued in full respect of environmental,
financial and social considerations.

Desig