Foreign and domestic investors have turned positive toward Italian financial services. Giustizia per la Crescita - Justice for Growth - a decree converted into law this summer introduces measures on bankruptcy law and fiscal deductibility for loan loss provisions. The law contains new provisions on debt restructuring/moratorium agreements and arrangements with creditors that could result in a speeding up of the recovery process of NPLs. Deals are in the pipeline to tap Italys EUR185.5bn NPLs.
Another reform converts the Popolari banks into joint stock companies, paving the way for the long-anticipated consolidation of Italys mutual banking sector, worth EUR750bn in tangible assets.
The relatively weak profitability of Italian banks is due to a variety of factors, including the countrys lacklustre economic performance, a prolonged period of lower interest rates, high corporate debt, and high fixed costs and expensive branch networks. Giorgio Gobbi, Head of the Financial Stability Directorate, Bank of Italy discussed his outlook for the Italian banking sector with Euromoney Conferences Giada Vercelli at the Italy Conference in Milan in September.
EC: The industry has been depicted as quite static for many years and now everyone is on stand-by for the expected consolidation driven by legal and regulatory changes. Has the Italian banking sector really been that static over past years, particularly given the efforts made by some banks in revising cost structures?
GG: Following the 2007-2008 financial crisis, the structure of the Italian banking system did not experience any major changes. This was not by chance and was mainly due to two factors. Firstly, in contrast with what happened in other countries, in Italy the crisis did not result in the default of any major institution. There was therefore no urgent need to consolidate. Secondly, when the global financial crisis started, the industry had already been through one of the largest consolidation waves in its history. The merger of Banca Intesa and SanPaolo IMI, the acquisition of Capitalia by UniCredit and of Antonveneta by MPS, and the creation of two large groups headed by popolari banks (UBI Banca and Banco Popolare), all took place in 2007 and 2008.
The crisis and the ensuing double-dip recession triggered, instead, a sort of internal consolidation. Italian banks reacted to the decline in profitability caused by a fall in income and an increase in loan loss provisions by launching an extensive organisational restructuring. This allowed for a significant reduction in operating expenses, in particular staff costs. Between 2008 and 2014 the industry as a whole cut the number of branches by 8% and the number of employees by 12%. The reduction was concentrated among the largest intermediaries which were those involved in the 2007 to 2008 mergers. Once the economic recovery consolidates, allowing banks to recoup from the fall in income and to (at least) halve their loan loss provisions, ROA could regain its 2004 to 2007 levels.
EC: The Bank of Italy has emphasised the message of not interfering with the markets. Perhaps in response to criticism in the past of acting as Deus-Ex-Machina behind banks M&A. What is the current attitude towards international players looking at Italy?
GG: Mergers and acquisitions in the banking industry, as in any other industry, should not be hindered as long as they are beneficial to consumers and efficiency-enhancing. By and large Italian banks operate a traditional business model based on retail funding and business lending, and past experience shows that economies of scale have been difficult to achieve. It is not yet clear how the IT revolution will affect the industry: markets are likely to know better than regulators on these matters.
Generally speaking, the performance of Italian banks has suffered from the prolonged recession in Italy. Market initiatives aimed at bank consolidation should be considered and evaluated based on their impact on financial stability, competition and efficiency. Regarding international players, the Italian banking industry is already one of the most open to foreign capital among the large European continental economies. Two of the largest ten banks are subsidiaries of foreign banking groups. In 36 banking groups, including the three largest ones, foreign investors have an interest of more than 5% of equity capital. It is fair to say that international investors are well aware of both the weaknesses and the potential of our banks and we encourage them not to underestimate the opportunities they can offer.
EC: Such a wave of change may be an opportunity for many Italian banks to modify their business models in order to address costs and revenues. Are we looking at banks focusing more on advisory and less on SSAs for instance? What are the business lines you will see emerging in order to comply with stricter regulations, and higher liquidity buffer requirements?
GG: Banks will have to adapt their business models to the changing environment. Nevertheless, there are some specific features of the Italian economy that will likely keep Italian banks in the traditional camp. On the liability side, the Italian banking industry can rely on a large retail funding base. This is due to the still relatively high stock of financial assets in household portfolios and to the central role that banks play as distributors of financial products (insurance, mutual funds, etc.) and as consultants in household savings allocations. In the future, banks will be required to strike an optimal balance between their deposit supply and the supply of (often third party) savings products, managing the trade-off between their funding needs and the drive to increase fee income.
EC: What about assets?
GG: On the asset side, bank deleveraging and overall market conditions induced a significant number of large and medium-large firms to increase their market funding. This is a welcome change, since Italian firms excessive dependence on bank funding proved to be a weakness during the financial crisis, and we are confident that the trend will not be reversed. In fact, we hope it will gain further momentum. This will be a great opportunity, especially for the largest intermediaries, to diversify their sources of income and to increase their advisory role.
EC: Nevertheless, the Italian economy features a very large number of small and medium-sized firms that will most likely continue to rely on banks as a major source of funding....
GG: True. However, the double-dip recession swept away a large number of inefficient firms; it widened the gap between innovators able to compete in the global markets and firms that were not able to adapt to the new challenging environment. It is likely that a large proportion of the firms that survived are well positioned to take full advantage of the economic recovery. According to our latest surveys, in 2014 R&D expenditure by industrial firms grew by 7%. Between 2012 and 2014 almost 40% of these companies adopted major product or service innovations; about 60% of them plan to increase exports in the next three years. Banks that will be able to finance the investment plans of these firms will have the opportunity to combine their traditional business model with satisfactory profitability.
EC: In Europe access to the capital markets is still limited, hence the push towards a Capital Markets Union, and various initiatives by the national government, including the decreto sviluppo and the destinazione Italia. The Italian system is heavily bank-centric. If banks are still cautious in lending, how can you respond to the criticism over the Italian system being a zero-credit system?
GG: I would not be so negative about Italian banks willingness to lend. Loans to firms and households are showing signs of recovery. In July the three-month annualised growth rate of loans to firms turned positive (0.7%, up from -0.2%) for the first time since November 2011. Moreover, according to the responses provided by Italian banks to the Bank Lending Survey (BLS) relative to the second quarter of 2015, banks eased credit standards as balance sheet and liquidity conditions improved and competition among banks increased. Recent surveys of manufacturing firms show that credit conditions are improving. Negative figures on credit growth are partly due to the large share of firms with non-performing loans. Looking at those firms whose loans are performing, the year-on-year credit growth recorded last June was slightly positive (0.1%). More importantly, loans to industrial and service firms grew by 2.8% and 1.0% respectively.
EC: Italian firms excessive dependence on bank funding proved a major weakness during the recession. Do you have high expectations on the development of the Capital Markets Union?
GG: Firms suffered from the banks need to deleverage and from higher funding costs and the banks incurred substantial losses on business loans. If properly implemented, the CMU should help European companies diversify their sources of funding, increase access to credit for SMEs, and make markets more effective and resilient. It will be no easy task to eliminate or greatly reduce the domestic bias in a European system composed of 28 different legal systems particularly in the fields of corporate governance, company law and insolvency law and different tax regimes. Nevertheless, if each stakeholder does their share, I am confident that it can be done.
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