Speech by the Governor of the Bank of Italy
Ignazio Visco
Recent economic developments
The moderate acceleration in global growth under way since the summer may continue this
year and the next, bolstered by the expansionary stance of the fiscal policies announced in the
United States and by the effects of those enacted in China and in Japan, where monetary policy is
also highly accommodative. The outlook, however, remains subject to a high degree of uncertainty.
The scale and components of the new US administration's policies remain unclear. So far, the
increase in medium/long-term interest rates in the United States, also spurred by anticipation of such
policies in an economy with close to full employment, has been transmitted to the other main
countries to a limited extent owing to divergent monetary policy stances. Adverse effects on the world
economy could arise were a further increase in yields, linked to higher risk premiums, not to be
accompanied by a parallel improvement in growth prospects and were capital outflows from emerging
economies to become more intense. The US administration's declared intention of slowing down or
reversing trade liberalization processes, and the steps it has already taken in this direction, risk
triggering tit-for-tat measures in other countries, with negative repercussions for world growth.
In the euro area the economic recovery is proceeding slowly. The measures adopted by the
ECB Governing Council have greatly curtailed the risk of deflation and paved the way for a gradual
return to monetary stability. The rise in inflation in December is, however, largely ascribable to the
energy components of the HICP and to other highly volatile items; there are as yet no clear
indications of any inversion of trend in the core components driving developments in consumer
prices and wage growth, even in countries where unemployment is lower. The Eurosystem's
projections put inflation at barely above 1.5 per cent in 2019.
To bring inflation back to a path consistent with medium-term price stability, monetary
conditions must continue to be highly accommodative. The Governing Council accordingly decided
to extend the expanded asset purchase programme until end December 2017, or beyond, if necessary,
and to trim monthly purchases back to €60 billion starting in April. At the end of this year these
purchases will amount to around €2,300 billion. The Council expects official rates to be held at levels
equal to or below the current ones for a period that extends well beyond the programme's horizon.
The Bank of Italy is continuing its purchases of public-sector bonds, ensuring orderly
conditions on the secondary market, including through securities lending operations; for covered
bank and corporate bonds we also intervene during the placement of new issues, thereby increasing
the availability of funds. There has been intensive and increasing interaction with market operators;
since April purchases of asset-backed securities, previously also concluded by external asset
managers, will be made entirely by national central banks.
In the euro area too, uncertainties abound regarding developments in the real economy.
Growth in productivity continues to be insufficient. Capital investment still needs reinforcing.
Strengthening output and at the same time addressing the effects - though positive overall - of new
technologies on employment requires the contribution, not only in Italy, of other policies and
interventions in addition to monetary policy measures.
In Italy the production of goods and services continues to increase, though the pace of the
recovery is slow and lags behind average rates in the euro area. Labour market conditions have
improved; business confidence remains solid while the decline in consumer confidence came to a
halt in the autumn. The data for the last two months largely confirm our projections. In the most
recent scenario outlined in last week's Economic Bulletin, gross domestic product is forecast to
grow by around 1 per cent on average per year in 2017-19.
Nevertheless, the scenario is susceptible to risks. It assumes, aside from favourable
conditions worldwide, that medium and long-term yields will remain low and that the pace of
growth in lending will continue to pick up in an economy in which alternative forms of financing to
banks are struggling to gain a foothold.
The maintenance of orderly market conditions, consolidation of growth, recovery of
investment and further improvement in the labour market assume above all that Italy will press on
with its reforms of recent years. The consequences of greater uncertainty over the political will to
pursue an indispensable modernization agenda must not be underestimated. So far, and
notwithstanding the less favourable assessments of credit rating agencies, the effects on the
financial market have been limited. However, the spread between the yield on ten-year BTPs and
the corresponding German Bund is around 50 basis points higher than the average observed in early
2016 and has widened considerably with respect to Spain.
Banks and credit risk
The economic recovery is being reflected in the indicators of credit quality, which continue to
show an improvement. In 2016 the flow of new non-performing loans (NPLs) reached its lowest level
since 2008; from the end of 2015 the stock of outstanding NPLs also began to diminish, albeit
gradually. Nonetheless, they continue to weigh heavily on the balance sheets of Italy's banks and there
have been repeated calls for better, firmer and more comprehensive management of these exposures.
Last June bad loans and other NPLs on the balance sheets of Italian banks amounted to €191
billion net of write-downs, that is 10.4 per cent of total loans. Including write-downs, NPLs came to
€356 billion, a figure frequently quoted in debates, which refers to the face value of the exposures
and accordingly does not represent their actual weight in banks' balance sheets. Out of €191 billion
of NPLs, net bad loans, i.e. exposures to insolvent debtors, amounted to €88 billion or 4.8 per cent
of loans. The remaining €103 billion pertained to situations in which regular repayments may
resume, especially if the recovery gains momentum.
The bad loan recovery rate effectively recorded by Italian banks averaged 43 per cent over
the ten years 2006-15, a proportion largely in line with banks' balance sheet figures. Our studies
point to a wide dispersion of recovery rates: for many banks the margin for improvement is
considerable and must be rapidly exploited. The first two rounds of new bad debt reporting received
and analysed by the Bank of Italy last year revealed that there is still some way to go in creating
detailed and easy-to-access databases.
In the two years 2014-15, recovery rates dropped to an average of 35 per cent. This was
partly due to an increase in the number of positions closed following 'en bloc' market sales to
specialized investors: in the ten years considered, the average recovery rate for these sales was 23
per cent, against 47 per cent for positions closed following standard procedures. The market prices
of exposures should be assessed bearing in mind that they reflect the very high yields demanded by
oligopolistic buyers, which also factor in the possibility of long recovery times; in some cases the
existence of a large proportion of long-standing bad debts, already amply written down, explain the
particularly low selling prices.
The large volume of Italian NPLs has drawn the close attention not only of the supervisory
authorities but also of international markets and observers. It requires careful management. The
majority of bad loans are held by banks in a sound financial position that therefore do not need to
sell them immediately. For the more problematic banks, ridding themselves of a legacy of bad loans
is an essential step towards recovery. The best trade-off between sales on the market and internal
management is a matter for individual assessment. From this perspective, the draft guidance on
NPLs recently issued by the ECB's Single Supervisory Mechanism advises banks to actively
manage these exposures and calls on those with a large proportion of NPLs to draw up suitable
plans to reduce them.
Numerous well-known factors have contributed to Italy's high level of NPLs. The most
important by far, however, is the long and deep recession, which has undermined many firms'
ability to repay debts, which were not always granted with sufficiently careful assessment. The
length of credit recovery procedures has also played a part: if recovery times in Italy were in line
with the European average, the ratio of bad debts to total outstanding loans would be about half
what it now is.
Furthermore, setting up an asset management company with public funding, as other
countries have done in the past, has now become impossible owing to the new European rules on
State aid introduced in 2013 and their rigid interpretation. Previously, during the sovereign debt
crisis, given serious market concerns about the sustainability of Italy's public debt, any action by
the State was unlikely to be successful. Moreover, in contrast to the situation in countries where real
estate bubbles burst, the deterioration in bank lending was not confined to specific sectors of the
economy; the international institutions and leading forecasters projected a far more rapid exit from
the crisis than was actually the case.
Many of the necessary conditions for solving the problem of non-performing loans are now
in place. As I mentioned earlier, the economic recovery is being reflected in the quality of credit; as
it gradually gains pace, the banks will be able to repair their balance sheets. The reforms of the last
two years should also improve the credit recovery process. It is still too early to see the full results
as the greatest impact will be on 'new' bad loans. However, some of the measures, especially those
relating to out-of-court solutions for corporate debt restructuring and the transfer of ownership of
real guarantees, are already in place and could make a difference to the stock of NPLs: they should
be activated without delay.
Recovery procedures could be further speeded up by implementing the other tools
offered by the new rules: the portal for public auctions (now being trialled); the online register
of non-possessory liens and that of foreclosures and bankruptcy proceedings; the extension to
consumers of the Marcian Pact forfeiture clause. Further improvements might include additional
specialization of judges in bankruptcy proceedings and reducing regional differences in courts'
performance.
An important contribution on the European front could come from a regulatory provision
eliminating or limiting the measures that discourage banks with advanced internal ratings-based (A-
IRB) models from selling their NPLs 'en bloc'. Including the impact of such sales in estimates of
the loss given default (LGD) parameter automatically raises capital requirements considerably on
all performing loans and consequently reduces capital ratios. Analyses based on a sample of Italian
banks show that this reduction could be significant. The measure would take account of the
exceptional nature of the present economic situation and the need to combine supervisory with
macroprudential objectives.
Banks' capital and support measures
An exceptionally deep and protracted recession such as the one experienced by the Italian
economy has undoubtedly had serious repercussions for the banks. Nevertheless, at the origin of the
worst crises we also find corporate decisions that were undermined by misconduct and distortions in
the allocation of credit. The fact that the greatest difficulties involve banks which taken together
account for a relatively small share of the industry's total assets is an indication of the overall
resilience of the system. Since the onset of the financial crisis, and partly as a result of pressure
from the supervisory authorities, Italy's banks have almost doubled their CET1 ratios and are
continuing to increase them, including by raising funds on the market.
The national and European supervisory authorities have been monitoring the most critical
situations for some time. The measures adopted were designed to reach orderly solutions and avoid
repercussions for the stability of the banking system, within a rapidly changing regulatory environment
that precluded any recourse to the instruments successfully used in the past and before the new
instruments became fully available. Various measures were taken to deal with the different situations.
With the help of the National Resolution Fund, to which all banks contributed, four banks at
risk of failure were placed under resolution at the end of 2015, thus avoiding any need for a publicly
funded recapitalization, although to cover the losses it was also necessary to reduce the value of
subordinated bonds to zero. The only alternative to resolution was to wind them up, which would
have cost their creditors even more and involved others in addition to shareholders and subordinated
bond holders. Different types of protection were introduced for the subordinated bond holders
according to their individual situations and the Interbank Deposit Protection Fund has started
disbursing compensation.
Despite the difficulties of the current regulatory and market environment, there have been
important developments in recent days as regards the sale of the four bridge banks. The agreement for
the sale of three of these banks to UBI Banca has been signed and the negotiations for the sale of
Nuova Cassa di Risparmio di Ferrara to Banca Popolare dell'Emilia Romagna are at an advanced
stage. The sizeable cost of these operations has been borne by the National Resolution Fund and
therefore by the banking system. The greatest care has been taken to keep costs down, including by
means of an open and transparent sales process conducted in close collaboration with the Ministry of
Economy and Finance and the European Commission, which assessed all valid offers on the table
from Italian and foreign interested parties. The special purpose vehicle that bought the bad loans of
the four banks is continuing its efforts to arrange a sale at the best possible terms and conditions, with
the help of independent experts; this requires the information on the loans to be vastly improved.
The experience gained in the months since the start of the resolution procedure for the four
banks should, however, also lead us to reflect on the potential systemic significance, in a closely
interconnected market, of regional banks with a limited catchment area.
The measures taken in Italy in 2016 have made it possible to deal constructively with other
crisis situations, with the contribution of both the public sector, including as a facilitator, and the
private sector, through recourse to various instruments: precautionary recapitalization by the State
(recently requested by Banca Monte dei Paschi di Siena); private funds specifically raised to buy
NPLs and to strengthen the capital of banks in difficulty, used in the case of two banks (Banca
Popolare di Vicenza and Veneto Banca); and the voluntary component of the deposit guarantee
funds (to support smaller banks).
In full compliance with European rules and to guarantee financial stability, public resources
have recently been allocated (up to €20 billion) to support the liquidity and capital positions of
solvent banks which, despite achieving a positive result in the baseline scenario of a stress test, must
deal with shortfalls found in a hypothetical adverse scenario that is part of the same test. This
measure is an important one for Italy as it emerges from the crisis that buffeted its economy and
banking sector.
State intervention is much more limited in Italy than in almost all other European countries,
helping to remove the market's perception of a risk considered high for the entire banking system.
The costs for the public purse will be reduced by burden sharing among equity holders and
subordinated bond holders. It will be possible to offset them against the proceeds of future sales of
shareholdings. A necessary condition for benefiting from public precautionary recapitalization is the
approval by the European Commission of a restructuring plan drawn up by the bank.
The injection of public funds into Banca Monte dei Paschi di Siena will presumably use up
about a third of the €20 billion set aside by the Government. There is more than enough room to
address the recapitalization needs of any other Italian banks that meet the conditions laid down in
the decree, in the first place those relating to the results of a stress test. However, for other measures
to be implemented the banks must be willing to apply for public support and to deal with the
ensuing commitments.
Following the capital strengthening carried out under the Fondo Atlante, the senior
management of Banca Popolare di Vicenza and of Veneto Banca have been drawing up an
industrial plan for their further recapitalization and relaunch, which will soon be presented to the
supervisory authorities. The feasibility of a merger will be examined with a view to achieving cost
savings and synergies capable of ensuring a return to profitability.
The challenges for the banking system
Aside from the difficulties of some banks in particular, the banking system as a whole is
called on to face new and demanding technological and market-related challenges, on which we
have often reflected. This is not only a necessity for Italy: a return to higher and lasting profits is a
must for all European banks. The way in which branch networks are structured, services provided,
and technologies used, must all be reviewed in a bold and innovative spirit. Value creation in the
banking industry has changed and continues to do so; Italian banks can no longer put off much
needed restructurings and strategic reviews. Only in this way can they continue to successfully
attract investors; only then can they continue to compete effectively and maintain their stability.
In some cases capital strengthening on the market will need to continue, as is already
happening for some large banks; experience has shown that if requests for new capital are based on
clear, ambitious and, at the same time, credible plans, then they are likely to be successful, even in
tough market conditions. In other cases, especially for medium-sized banks, mergers are necessary
to achieve cost savings and increase operational efficiency. The success of these mergers crucially
depends on the ability to streamline banks' organizational arrangements and to improve corporate
governance, also in terms of market perception.
The reform of cooperative banks (banche popolari), which pursues the goals of efficiency,
transparency and stability, is almost complete: eight out of ten of those with assets exceeding €8
billion - the threshold established by law - have become joint stock companies. The merger of two
of them has created a banking group of significant size. Other mergers can be achieved and may act
as catalysts for the restructuring of the entire banking system.
Last December the State Council requested that the Constitutional Court rule on a number of
questions regarding the reform's constitutionality; the deadline of end 2016 for compliance with the
new rules was suspended, as were some parts of the implementing provisions issued by the Bank of
Italy as mandated by law. The reform is necessary as it will facilitate capital strengthening for the
banks concerned and contribute to improving their governance. The limitation of the right to
reimbursement in the event of withdrawal aims to preserve the integrity of capital levels and draws
inspiration from the European rules, which are not currently under consideration by the Court.
At the beginning of this month the supervisory authority sent a communication to the mutual
banks (banche di credito cooperativo) and their central institutions urging them to carry out the
reform of their sector rapidly and effectively. Only a swift transition to the new set-up will enable
mutual banks to strengthen their capital position where necessary and continue to provide their
traditional support to local economies in the best way possible, also in view of banking union.
Returning to a level of profitability that enables stable capital strengthening is a fundamental
objective for banks, particularly those currently on a weaker footing. A determined and incisive
approach to keeping administrative and labour costs down, including for management, must be
adopted using all the tools currently available.
The density of Italy's banking network and its productivity do not diverge greatly from
those of other euro-area countries. According to the latest ECB data on 2015, average assets per
bank employee in Italy (€13.1 million) are lower than the euro-area average (€15.3 million). In Italy
there is one bank branch for every 1,993 inhabitants, against an average of 2,170 for the euro area;
there are slightly fewer branches in Germany, with one for every 2,397 inhabitants, but more in
France and Spain, with one for every 1,770 and 1,493 inhabitants respectively. There is
considerable scope for rationalization across the board: though the financial system in the United
States has different characteristics from the European one, there are still far fewer branches per
inhabitant there (one for every 3,900). It is vital to continue reviewing the network and increasing
its productivity, by exploiting rather than being a victim of changes in technology, the market and
customers' habits.
* * *
The recovery continues in Italy, albeit gradually, thanks to the improvement in the global
economy and to the expansionary stance of monetary policy. Credit quality is benefiting as a result.
All the banks need to take decisive steps to tackle the problem of NPLs: the solutions should be
assessed individually. The foundations have now been laid for solving the particularly serious
problems of some banks, thanks to the instruments developed and the measures adopted by the
authorities.
To improve their profits and contribute efficiently to financing the economy, banks must
make further progress in containing costs, upgrading technologies, and streamlining their
organization and branch network. Updating their business model is also essential in order to provide
customers with a broad and innovative range of services for asset management and corporate
finance.
A stronger recovery and sounder banking system are closely connected and also depend on
firms, households and international markets' confidence in Italy's ability to carry forward the
reforms begun in recent years. To prevent this confidence from being undermined, the country must
continue resolutely on this path: by improving the efficiency of the State and of the entire public
sector in lawmaking, administration, and the delivery of services to citizens; by creating a business-
friendly environment; and by promoting research and innovation.
Stability and reform are essential for development. There are no shortcuts, particularly for a
country burdened with such a large public debt and such persistent structural problems. Second
thoughts, delays and resistance, not uncommon in some sectors including banking, risk affecting
market conditions and undermining the progress achieved during the long economic crisis from
which we are now, though slowly and laboriously, emerging.
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by the Printing and Publishing Division of the Bank of Italy