Italian Banking Association
Annual Meeting
Speech by the Governor of the Bank of Italy
Ignazio Visco

The economic situation and outlook
The world economy is struggling to regain momentum. According to the
main international institutions, GDP growth this year will be at its lowest since the
contraction of 2009. In the Economic Bulletin that will be published this afternoon,
the pace of international trade growth is estimated to be 1.5 per cent, more than
two and a half points lower than in 2018. Downside risks linked to protracted trade
tensions, the slowdown in the Chinese economy, and the unknowns surrounding
the timeframe and arrangements for the United Kingdom's exit from the European
Union, are weighing on the economic outlook.
Growth remains weak in the euro area. The uncertainty regarding the world
economy is having a negative effect on exports, manufacturing production, and
firms and households' expectations. According to the projections made in June by
the Eurosystem, GDP is expected to increase by 1.2 per cent in 2019, while the
forecast for 2020 has been lowered to 1.4 per cent. The growth in prices remains
modest and financial markets' inflation expectations are particularly low.
At the beginning of June, the ECB Governing Council confirmed its
strongly expansionary monetary policy stance. If there is no improvement in the
macroeconomic outlook, further measures will be needed. Over the next few weeks,
the Council will continue to consider how to recalibrate the tools at its disposal.
Despite the slight improvement in the first quarter of this year, economic
activity is stagnating in Italy, owing above all to the slackness of the industrial
cycle. According to our surveys, firms expect a slowdown in demand over the
coming months and very modest growth in investment over the year as a whole.
The central projection included in the Bulletin puts GDP at 0.1 per cent in 2019
and at just under 1.0 per cent on average for the following two years. These
estimates are subject to risks connected with both international developments and
domestic demand. The confidence of households and firms could be affected by
the uncertainties surrounding the budget, which have been dispelled for this year
but not for the next.
At a time of a generalized reduction in risk premiums, reflecting expectations
of greater monetary accommodation in the euro area, tensions on the Italian
government securities market have abated. Thanks to the European Commission's
decision not to recommend the launch of an excessive deficit procedure, following
the reduction in expected net borrowing for the current year, the yield spread
between Italian and German ten-year government bonds narrowed further and
yesterday was below 200 basis points.
To build on these results and reduce the cost of public debt further, the prudent
budget policy stance must be confirmed over a longer time horizon. The yield
spread compared with the corresponding German Bund is still around 70 points
above the not low levels prevailing in April 2018. The yield spread with respect to
Spain, which, like Italy, was severely hit by the sovereign debt crisis, is over 120
points; it had been around half a percentage point in April of last year. If the spread
continued to narrow and were the cost of debt to fall below the nominal GDP
growth rate, as has already happened in the other euro area countries, it would be
easier to lower the debt-to-GDP ratio.
Narrowing the spread would also attenuate the risks for credit access
conditions. The tensions over public debt securities have pushed down private
bond prices and the corresponding issue prices, especially for banks. There has
been little effect so far on interest rates on loans, in part thanks to high levels
of liquidity and the improvement in banks' balance sheets. Nevertheless, signs
of a tightening of credit access conditions have been emerging since mid-2018,
especially for smaller firms and for those in the Centre and South; at a time of weak
credit demand, this has led to a moderate contraction in loans to non-financial
corporations since the beginning of this year.
The conditions of Italian banks
Italy's banking system has progressively strengthened over the last few years,
and credit quality has improved. Cautious lending policies, together with the albeit
modest economic recovery, has kept the new non-performing loan rate down;
prudent provisioning, more effective recovery processes and increasing recourse
to NPL sales have driven the reduction in the stock of non-performing loans.
Compared with the peak of 2015 and net of loan loss provisions, NPLs have more
than halved, falling from €196 billion to €88 billion last March; their ratio to total
loans has gone down from 9.8 to 4.2 per cent.
Profitability has shown signs of recovery, linked to the reduction in loan loss
provisions and the gradual decline in operating costs. Return on equity has been
positive since 2017. Liquidity conditions have also progressively improved; some
banks have resumed bond issuance on the wholesale markets since the end of
last year, though at costs that are still higher than those recorded in the spring of
2018. Capital ratios, which up until last September had been affected by tensions
on the government securities market, increased again; last March, the CET1 ratio
averaged 13.2 per cent.
In the first quarter of this year, the ratio of new non-performing loans declined
for firms as a whole, but increased slightly in some sectors (construction and
manufacturing); net interest income, which was already low, fell further. The
prudent lending policies implemented by banks could mitigate the impact of the
cyclical slowdown on the flows of non-performing loans compared with those
observed in the past. Operating costs need to come down further so as not to
penalize banks' profitability again.
Tensions in the government bond market affect the value of the assets that
are eligible as collateral in the Eurosystem, push up funding costs, and have
a negative effect on banks' capital, given the losses on portfolio securities
calculated at fair value. In the second quarter of 2018, for example, the
increase in yields on government bonds reduced the capital ratio by about half
a percentage point on average. Compared with April of last year, the market
rates for bank bonds are now higher by about 15 basis points in Italy, while
they are 45 basis points lower in the rest of the euro area. The rating agencies
are maintaining their negative - or at best stable - outlook as regards any
shifts in Italy's credit rating. This is also why there is an urgent need to define
a strategy to support investment and innovative enterprises within a credible
framework for public debt reduction.
The situation of the less significant banks other than mutual banks (BCCs) is
still characterized by specific weak points. For most of these banks, profitability
continues to be lower than that of the significant groups and their NPL ratio is
higher. Some are affected by inadequate corporate governance and risk control
structures. The problems tend to be worse for banks in Italy's Mezzogiorno, mainly
because this region faces greater economic difficulties. Their balance sheet assets
are, on average, half those of banks in the Centre and North; their legal form is
most commonly that of a banca popolare (9 banks out of 16, against 12 out of 78
in the rest of the country); the assets attributable to the popolari account for more
than 90 per cent of the total, compared with 10 per cent in the Centre and North.
As we have often pointed out, it is more difficult for popolari banks to turn to the
market for the funds they need to strengthen their capital and to finance business
growth and innovation.
In the past few years, the Bank of Italy has introduced a series of measures
covering all smaller banks, in part to prevent the emergence of critical situations.
Action was taken to encourage new investors in banks' capital and, where necessary,
mergers with other intermediaries. Banks have been urged to reduce their credit
risk and strengthen NPL management and recovery. They have been asked to
adopt appropriate measures to reduce operating costs and diversify income flows,
for example by using consortium-based initiatives, reorganizing branch networks
and containing staff costs.
The most problematic situations have been managed through market
solutions that safeguarded financial stability and protected depositors. Until the
first few months of last year, also thanks to greater confidence in the economic
outlook for Italy and the euro area, the involvement of qualified investors made it
possible to relaunch a number of banks, whose business models were completely
overhauled and adapted to the new competitive scenario. However, in the current
market environment, investing in the capital of smaller banks is considerably less
attractive. Restructuring operations have become more difficult, partly due to the
perception that their possible outcomes are much less certain.
In this context, and given the limitations imposed by the European rules for
managing crises at smaller banks, the less significant banks must work together to
identify solutions to secure their business and relaunch their activities. On the one
hand, links with their local area cannot be the only factor in their development;
knowledge of markets and operators must be accompanied by more intensive use
of new technologies to increase operational efficiency and to make the supply
of customer services more competitive. On the other hand, banks must reap the
benefits that being larger can bring in terms of economies of scale and a strong
capital position. We are mindful that consolidation is a complex process, but
preparatory work must begin at once to move in that direction, defining projects
of common interest in areas such as technological innovation, the pooling of
auxiliary activities and their related costs, and the development of synergies in
service provision. It is fundamental to establish balanced governance structures
that avoid conflicts of interest and meet the objective of financing the real economy
in conditions of full efficiency and adequate profitability.
In the last few months, the two new mutual banking groups that are now
classified as significant for supervisory purposes have started operations. Most
of the BCCs (224 out of 263) have joined these two groups. Fully reaping the
benefits of the reforms of this sector will largely depend on the effectiveness
of the interaction between the parent banks and the individual BCCs in raising
efficiency and profitability, harnessing economies of scope and improving
credit management processes, including on the basis of the Single Supervisory
Mechanism's Comprehensive Assessment. The necessary streamlining measures
will have to be carried out promptly, particularly in relation to the profitability
of the branch networks and their size. The capacity of the BCCs to continue to
serve their territories of reference requires risk management and control systems
that converge rapidly towards high standards, mostly to prevent the emergence of
improper business relationships or conflicts of interest. The parent companies must
act decisively when exercising their powers of intervention under the new regulatory
framework and when tackling the problems of BCCs with structural weaknesses.
Full compliance with the rules on transparency and adequate customer protection
are necessary conditions to foster trust in banks and preserve their reputation;
such conditions contribute to financial stability. The Bank of Italy is committed to
strengthening regulatory defences; supervisory action is aimed at both individual
banks and at particular problem areas. The work of the Banking and Financial
Ombudsman strengthens individual protection, but a decisively proactive approach
on the part of the banks is needed, turning organizational measures aimed at ensuring
compliance with rules and provisions into an effective strategic choice.
The significance of the risk posed by the financial sector's possible involvement
in criminal activity in connection with money laundering is confirmed by recent
events at some major European banks. Targeted initiatives have been launched to
strengthen oversight in the individual EU member states, to set up mechanisms for
cooperation among national authorities, and to integrate money laundering risk
assessments into prudential profiles. It will be possible to assess the effectiveness
of these measures in the near future. In Italy, our supervisory activity makes a
significant contribution to ensuring that banks are not vulnerable to criminal
infiltration; one of our strengths is our proximity to and close cooperation with the
Financial Intelligence Unit. In this area too, it is essential that banks remain highly
vigilant with respect to the monitoring of risks.
Over the years, cooperation with the judicial authorities has been intense:
in the three years 2016-18, the Bank of Italy awarded more than 350 technical
consultancy contracts, answered almost 700 requests for information, and issued
more than 280 communications. Support for the public prosecutor offices most
heavily engaged in combatting financial crime has been stepped up. One tangible
symbol of this is the memorandum of understanding that will soon be signed with
the public prosecutor's office in Milan, where a team of our experts has already
been working since 2009.
The challenges posed by regulatory developments
The European Banking Authority recently published the methodology to
be used for the next round of stress testing, which will begin in early 2020 and
involve 50 intermediaries, of which four are Italian. As in the past, the test is
not a pass-fail exercise; its goal is instead to support the Supervisory Review
and Evaluation Process (SREP). The consultation phase that has just begun is
intended to allow banks to prepare for the stress test.
The perception that the costs of the stress tests have become high with respect
to the benefits has led to a discussion on how to improve this tool. The Bank of
Italy is actively involved in this debate. A study we published in recent weeks
advocates for two separate tests: the first, to be conducted by the supervisory
authorities, for microprudential purposes; and the second, to be carried out by
the European Banking Authority in cooperation with the European Systemic Risk
Board, for macroprudential purposes. This distinction would be consistent with the
regulatory tasks assigned to the different European authorities.
Adopting a bottom-up approach, the microprudential exercise would focus
on specific risk areas identified as a priority by the supervisors; it would combine
static and dynamic assessments based on stress tests carried out by the banks and
subject to rigorous quality assurance by supervisors. The top-down macroprudential
exercise would instead assess the resilience of the entire European financial sector
to systemic shocks, using tests devised directly by the authorities and minimizing
the costs for the banks concerned. We hope that there will be a wide-ranging and
open discussion on these issues over the next couple of months.
In Europe work has begun to adopt the standards approved at the end of
2017 by the Group of Central Bank Governors and Heads of Supervision (Final
Basel III). The measures seek to reduce excessive variability in the calculation
of risk-weighted assets. The introduction of an output floor for the requirements
calculated using internal models and the new rules on market risks approved at the
beginning of this year to rebalance the relative weight of credit and market risks in
the capital requirements (Fundamental Review of the Trading Book - FRTB) will
be of critical importance.
There will be a long transition period before the standards enter fully into
force. Based on the information available, the effects of the new rules on Italian
banks, while not negligible, appear less significant than for the banks of the other
major European countries. However, Italian banking groups would do well to seize
the opportunity offered by the transition phase to prepare effectively, honing their
operational strategies and balancing profitability and capitalization needs.
In recent years, episodes of market manipulation and a significant reduction
in interbank transactions have jeopardized the integrity and representativeness of
the money market reference rates. To counter these risks, a process to review the
financial benchmarks has also been launched at European level, in line with the
recommendations of the Financial Stability Board. Starting on 2 October 2019, the
ECB will publish an index of the unsecured overnight borrowing costs of euro area
banks (euro short-term rate, €STR), which going forward will replace Eonia in the
indexation of financial instruments. Moreover, it is expected that before the end of
the year, Euribor, an important benchmark for indexed mortgage loans and other
financial contracts, will complete its migration to a new calculation methodology
which, where possible, will use data on the actual transactions of a sample of banks.
The use of benchmarks in the financial system is widespread; in Italy a large
amount of the banking system's assets and liabilities is indexed to Euribor. It is
essential that intermediaries identify and promptly implement the necessary measures
to ensure an orderly transition to the new reference rates, both for dealings with
customers and in terms of organizational and operational setups.
The objective of the rules on managing banking crises introduced in Europe
since 2014 is to enable failing banks to exit the market while minimizing the impact
on financial stability and the public accounts. This is a valid objective, whose actual
achievement has nonetheless been hindered by factors that require further reflection.
Some resolution tools, such as the bail-in, cannot be applied in the absence of
dedicated bank liabilities (TLAC and MREL) subscribed by qualified investors and
capable of absorbing the losses and recapitalizing the intermediary. It would take until
at least 2024 to build up the full stock of these liabilities, also due to the significant
costs that banks must incur in issuing them. In the meantime, in order to manage
bank crises solutions must be found that make it possible to draw on external sources
of funding even in derogation of the bail-in principle. Consistent with the IMF's
recommendations, when there are risks to financial stability these solutions should
remain available even after the stock of dedicated liabilities has been fully established.
Precautionary recapitalization should be more readily available to address any
market failures that restrict the ability of solvent banks to self-finance and to head
off the risk of contagion. Regulatory constraints that discourage investors from
participating in bank recoveries should be removed; these include, for example,
envisaging forms of protection for the financial contributions they provide and
strengthening the early intervention tools available to supervisory authorities,
including special administration.
The resolution procedure established at European level is only applicable to
a very limited number of large banks; in the event of a crisis, all the others would
be subject to liquidation in accordance with national laws, with no guarantee of
this taking place in an orderly manner in a way that avoids any impact on systemic
stability. There is an urgent need for European measures establishing a liquidation
framework that will not lead to business discontinuity, fire sales of assets, and
negative consequences for unprotected depositors, customers and the economy
as a whole. One reference model is that of the US Federal Deposit Insurance
Corporation (FDIC), under which deposit guarantee systems intervene to facilitate
the en bloc disposal of the assets and liabilities of the bank being liquidated (in an
institutional framework in which the deposit protection limit is higher than that in
Europe and the FDIC is not a super senior creditor).
More generally, the relationship between the regulatory framework on
banking crises and that on State aid must be reviewed. In addition to eliminating
the overlapping of jurisdictions and to clarifying uncertainties as to application,
there is a need for discussion and reconsideration of the principle whereby the
protection of competition, which underpins the rules on State aid, always takes
precedence over arguments for protecting financial stability.
Appropriate revision of the European bank crisis management framework
could help solve the problem of having failed to provide for an adequate transition
phase which the new system would have required. Such a revision would make
it possible to take better account of the fact that banks are, by their very nature,
exposed to the risks of contagion, unlike, as a rule, companies that operate in other
economic sectors. Legislative action on the part of the new European Commission
to revise the BRRD could provide an opportunity to rethink the current rules in
order to make the European regulatory framework more flexible and more at one
with the nature of banking.
In the European Union all banks are subject to many regulatory standards which,
in reality, were conceived with international banks in mind. While this ensures fair
competition within the Single Market and creates a robust framework that safeguards
stability, it imposes high compliance costs on smaller banks (despite the simplified
rules they benefit from, even on very important parts of the regulations, such as
market risk, employee compensation and reporting obligations).
Complex risks cannot but require detailed rules. However, an excessively
complex regulatory system can itself become a source of risk: it can generate
uncertainty as to the application of the rules, can serve as an incentive to conduct
business outside the scope of application of the rules, and may result in a
disproportionate burden on smaller or more specialized banks.
The opportunities and risks presented by technological innovation in the
financial arena
The challenges posed by technology are inescapable, for banks, for businesses,
for each and every one of us. Closing the gap that has accumulated over the last
thirty years in economic and financial innovation and in the skills of adults and
students requires a collective effort. Banks are expanding the range of traditional
services available online but have not yet begun to invest significantly in the latest
technologies. In industry, the recovery of competitiveness in the international markets
witnessed in recent years must be supported by policies that encourage firms to
innovate and expand. However, further progress can only be made if we all recognize
the importance of investing in culture and knowledge to provide an education that
encompasses not just the student years but people's entire working lives.
Digital technologies make it possible to increase financial inclusion, leading
to more efficient resource allocation and supporting investment and economic
growth. New ways of collecting large volumes of heterogeneous data and new
methods for analysing them (including artificial intelligence and machine learning
applications) make it possible to assess customer credit ratings more accurately
and the terms and conditions at which loans will be granted. The benefits of
using new technologies are greater in the payment segment and in that of loans to
firms that operate in sectors and areas in which lending is riskier. The advantages
of exploiting digital technologies tend to be greater for smaller banks, whose
customers are mainly small firms.
Nowadays, a number of crowdfunding platforms put firms in direct contact
with both retail and institutional investors, increasing access to funds. The use
of distributed ledgers for trading shares of unlisted SMEs, which are currently
being tested, reduces the costs of accessing capital markets. These technologies,
which are experiencing rapid growth abroad, can also make inroads in Italy, where
corporate financing mainly depends on the banking system.
Coping with the competition of new digital operators requires that banks
lose no time in investing, with adequate safeguards against cyber risks, in
both the latest technologies and in the formation of the human capital needed
to apply them successfully. In a market in which customer characteristics and
habits change rapidly, it is not enough to rely on maintaining trust in traditional
intermediaries.
The possible introduction of a virtual currency that could make the settlement
of some retail and financial transactions cheaper and faster was recently announced;
according to its architects, its value would be kept stable with respect to a basket
of the main world currencies. The fact that a private currency can originate in
a digital context may change the way in which traditional liquidity, market and
solvency risks manifest themselves, but it cannot eliminate them altogether. These
risks come with others, certainly no less important, linked to the security of savers'
resources, the protection of personal data, its possible use for the purposes of tax
evasion, recycling and terrorist financing and, given the potentially vast application
of this new means of exchange, to the potentially adverse effects on monetary and
financial stability.
The attention of regulators, central banks, supervisory authorities and the
other institutions involved is at a maximum. The information available still does
not permit a complete analysis of the risks associated with this type of proposal and
the measures required to counter them. It is important that all the parties involved
keep engaging in dialogue and stand ready to intervene to ensure the application
of the principle whereby the same activities are subject to the same regulatory
safeguards, regardless of who performs them, the necessary security standards are
upheld for the proper functioning of financial transactions, and everything possible
is done to maintain the trust of savers and to prevent abuses of authority. Account
must also be taken of the findings of assessments, still to be completed, of how
best to safeguard monetary and financial stability. In any event, the introduction
of private virtual currencies may entail risks of a different nature to those directly
connected with technological innovation, which in itself is desirable owing to the
significant advantages it offers. In this regard, even for the legal tender issued by the
central banks, assessments are under way of how best to exploit the opportunities
provided by advances in digital technologies.
* * *
The Italian Banking Association was established on 13 April 1919. In the
one hundred years since then, Italy has lived through the difficult interwar years,
the economic miracle of the 1950s and 1960s, the decline of growth between
the collapse of Bretton Woods and the early 1990s and, finally, a long period
also marked by two very severe crises, in which the economy's growth rate has
disappointed and production has stagnated.
In this latter period, Italy has paid the price for its delayed reaction to the
opening up of global markets and to technological change. It is a delay that has
also concerned banks, which are now called upon to make profound changes to
deal with competition, including from non-bank intermediaries, and to resume in
full their principle role as financers of the economy. Strengthening the solidity and
competitiveness of banking systems, in Italy as in Europe, calls for mergers to raise
efficiency levels and to improve banks' ability to make the necessary investments
in technology. At this critical juncture, ABI can encourage banks to anticipate
these changes as much as possible, by promoting, including at international
level, initiatives that favour innovation, the revision of business models, and the
strengthening of trust in the banking system.
Developments in finance and in the real economy are interdependent; the
more efficient financial intermediation is, the more possibilities firms will have to
develop their business; economic conditions affect the quality of banks' credit and
their profitability and capitalization. Economic policy must recreate the conditions
to ensure this interaction is beneficial and avert negative spirals.
Preserving the trust of households, firms and investors requires concrete,
resolute action to tackle Italy's structural weaknesses, accompanied by persuasive,
goal-oriented, and unequivocal communication. An organic plan with clear,
comprehensive measures, designed to boost firms' investment and growth, above
all of innovative firms, must go hand in hand with a credible strategy to reduce
the public debt. The markets have reacted positively to the recent decisions of the
Italian government and European Commission, proof that it is possible to trigger
a virtuous cycle between budgetary policies and financial conditions capable of
conveying a strong and lasting stimulus to economic activity.
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