31 May 2012

Bank of Italy/Visco: Overview of economic and financial developments in Italy

Since last summer, Europe and Italy have been in the throes of an exceptionally serious crisis. After the worst effects of the financial crisis that had broken out in the United States four years before had been reined in with much effort, and financial assistance programmes had been drawn up for the euro area countries in greatest difficulty with their public finances, banking systems and external accounts, for a year now new tensions have been present in the sovereign debt market. They were triggered not only by the deteriorating outlook for the global economy but also by the worsening of Greece’s financial situation and the fears caused by the announcement of the involvement of the private sector in reducing the country’s public debt. The tensions spread to the financial and banking markets of the euro area and had a direct impact on Italy and Spain.

The crisis was tackled on three fronts. The authorities of the most exposed countries made substantial corrections to their public finances and prepared structural reforms to foster growth, interacting with the European authorities; in Italy the actions initiated in the summer were completed and reinforced by the new Government. In the European Union the reform of governance was speeded up, the instruments for providing financial support to countries in difficulty were reinforced, and banks were required to strengthen their capital bases. The Eurosystem intervened with very-large-scale extraordinary monetary measures.

In these years, the stability of Italian banks has been assured by a series of factors: low exposure to structured finance products; regulation and supervisory controls to prevent excessive risk-taking; low leverage by comparison with other banks in Europe; and a high proportion of capital instruments effectively capable of absorbing losses. Contributory factors were the absence of any real estate bubble in Italy, and the low level of household debt. However, the credit system is feeling the repercussions of two sharp recessions in three years and the sovereign debt strains.

The Bank of Italy is working for the adoption of intensive and rigorous oversight and control practices. One element that is essential for guaranteeing systemic stability is the choice of method to measure risk-weighted assets, the denominator of capital adequacy ratios. Within the European Union there is wide dispersion of ratios of risk-weighted to total assets. The differences depend on balance-sheet composition and risk profiles; divergent supervisory practices also play a part. After the latest validations of internal models of risk measurement, for the five largest Italian groups the ratio exceeds 50 per cent, well above the European average. The peer review of the methods of calculating risk-weighted assets now underway within the Basel Committee and at European level accordingly needs to be completed without delay.

In the immediate future, above all the need is for convergent manifestations of the unshakeable will to preserve the single currency. If governments, the EU authorities, the European Central Bank itself, judge the progress of the troubled countries in financial restructuring and structural reform positively, this must be followed by a practical commitment on their part to orientate the markets’ assessments in the same direction. The current yield spreads of government securities do not seem to take account of what has been accomplished: they fuel further imbalances, leading to a redistribution of resources from countries in difficulty to those perceived as sounder; they impede the correct operation of the single monetary policy; they are a source of risk to financial stability, an obstacle to growth.

The instruments of financial assistance to states in difficulty must be made more effective in operational terms. There must be the possibility of intervening promptly in the securities markets and directly in favour of banks, with procedures that are more flexible and less penalising for the beneficiary countries that respect the rules of the Union. It must be possible to make effective use of the significant resources already allocated by the Member States.

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