Blog Post

Monday blues for Italian banks

On Sunday, the ECB and EBA published the results of their comprehensive assessment of banks balance sheets, and Italian banks where the worst performers. The stress tests singled out 25 banks that would be falling short of the 5.5% minimum CET1 threshold, based on data as of end 2013.

By: Date: October 28, 2014 Topic: European Macroeconomics & Governance

On Sunday, the ECB and EBA published the results of their comprehensive assessment of banks balance sheets, and Italian banks where the worst performers. The stress tests singled out 25 banks that would be falling short of the 5.5% minimum CET1 threshold, based on data as of end 2013. But once the measures already enacted in 2014 are taken into consideration, the number of banks failing the test is reduced to 13. Of these, 4 are Italian.

Banca Monte dei Paschi di Siena, Banca Carige, Banca Popolare di Vicenza and Banca Popolare di Milano will need to raise respectively 2.1bn, 0.81bn, 0.22bn and 0.17bn, for a total of 3.31bn. It is the largest share of the total net (of capital raised in 2014) shortfall of 9.5bn identified from the test.

13 banks are found to effectively fail the ECB stress tests. 4 of them are Italian

Markets gave Italy a very rude awakening on Monday morning. Milan stock exchange closed on Monday at -2.4%. By the end of the trading session MPS had lost 21.5% and was valued at 0.79 euros, whereas Carige ended the trading day down by 17% at a value of just under 0.08 euros per share.

But leaving the market reaction aside, the truth is that beyond capital some long-lived problems of the Italian banking sector have by now been known for a while but not addressed. In this respect, the comparison with a country like Spain – where the banking system has been subject to a deeper monitoring and restructuring during the financial assistance programme of 2012-13 – may yield striking insights.

First, the Italian banking system is still keeping in place a strong liason dangereuse with the (huge) government debt. This is not at all a special feature of Italian banks (as Figure 1 shows) but with almost 80% of their sovereign long direct gross exposures concentrated on Italy, Italian banks are found in this supervisory exercise to be among the most exposed to the sovereign debt issued by the domestic sovereign. Actually, if one excludes the countries that have been or are under a EU/IMF macroeconomic adjustment programme, Italian banks are the most exposed in the Eurozone (Figure1 and Figure 2 left).

Note: Long Direct Gross Exposure

Sovereign debt accounts for 10% of Italian banks asset on average and the home bias in debt portfolio seems to have increased since the last EBA test

More interestingly, the exercise shows that this “home bias”, which is deeply at the root of the sovereign-banking vicious circle that characterised the euro crisis, has even worsened over the last three years. Domestic exposure has grown (rather than decreased) as a percentage of total sovereign exposure on the books of all those banks that were already tested in 2011 with the exception of UniCredit (Figure 2).

Note: Long Direct Gross Exposure

Sovereign debt accounts by now for around 10% of total assets of Italian banks, on average. The carry trade on these holdings might have kept banks afloat over the last 3 years, but these gains are actually concealing deeper structural issues that Italian banks have – until now – never been forced to facein full.

One such long-known problem of the Italian banking system is profitability, which is (and has been for quite a while now) very low. According to ECB data, average return on equity has been negative over the period 2010-2013 and the comparison with Spanish banks is especially striking. After the huge drop in return on equity during 2012, Spanish banks recovered, whereas Italian banks seemed to have never done it (Figure 2).

After the huge drop in return on equity during 2012, Spanish banks recovered, whereas Italian banks seemed to have never done so

Differences between Italy and Spain are evident also in the reliance on Eurosystem liquidity and the pace of reimbursement, which until very recently has been significantly slower in Italy than in Spain (Figure 3 right). Italian banks have borrowed less – in absolute terms – from the ECB facilities, but have been sticking to the central bank liquidity for longer, accelerating reimbursements only in recent months. This may be explained by the fact that their alternative funding is relatively more expensive than it is for Spanish banks. Interest rates paid by Italian banks on retail (households’) deposits is in fact still significantly above those paid by their Spanish equivalents, not to mention German banks. More interestingly (and worryingly) deposit interest rates in Italy have only very recently started to drift downwards, contrary to Spain, where convergence has started earlier and moved faster.

These few elements depicts a gloomy Italian banking system which has been spared – until now – from the deeper monitoring and restructuring that have been undergoing in Spain and other programme countries, but at the cost of finding itself stuck in a limbo where lack of capital (in some cases), low profitability (in general) and rising bad loans are hindering credit and therefore further harming the potential recovery.

Even if the economic cycle were to improve and bad loans to subside, the low profitability will stick due to structurally high costs and inefficiencies

As pointed out, among others, by RBS’ Alberto Gallo, this is not a sustainable situation. Even if the economic cycle were to improve and bad loans to subside, the low profitability will stick due to structurally high costs and inefficiencies (such as Italy’s very high concentration of bank branches and length of the judicial process, for example).

One possible answer to these issues could be consolidation, which has been important in Spain but basically absent in Italy. This is partly due to specific features of the Italian banking structure, which make such reform very difficult. In particular, as shown in figure 4, banks are closely bound together by equity cross holdings in which bank foundations play often a significant role. And bank foundations are often dominated by local politics (see for example this summary account of professional politicians presence in Italian banks’ foundation boards), which may hinder consolidation on the bases of various (not necessarily economic) interests. This suggests that a meaningful reform process in the Italian banking system can hardly go separate from a deep restructuring of this governance structure.

Needed consolidation is made difficult by a corporate governance structure that is strongly tied with local politics

All these problems are long known, but have not yet been addressed. In our (Italian) language, there exists a fascinatingly peculiar expression: La Bella Figura. While it is impossible to appropriately convey all the nuances of its meaning, it could be broadly translated with “nice appearance” and it fits well also to the attitude that has until now been kept about the Italian banking system’s need for reform. Hopefully the stress test results will act as a wake up call, forcing some to finally acknowledge the importance of  substance over form.

Read more on the ECB’s "comprehensive assessment


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.


Warning: Invalid argument supplied for foreach() in /home/bruegelo/public_html/wp-content/themes/bruegel/content.php on line 449
View comments
Read article More on this topic More by this author

Blog Post

Revision of the Posted Workers Directive misses the point

The Commission’s proposed revision of the Posted Workers Directive has been approved by the European Parliament’s Employment Committee, which welcomes the arrival of “equal pay for equal work”. But the revision will have little impact, and was largely unnecessary. Instead we should focus on the fight against bogus self-employment, social security fraud and undeclared work.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: October 18, 2017
Read article Download PDF More on this topic

Policy Contribution

Spotting excessive regional house price growth and what to do about it

Rapidly rising house prices are a well-known source of financial instability. This Policy Contribution examines whether there are regional differences in house price growth within European countries and, if so, whether this warrants more targeted measures to address vulnerabilities.

By: Grégory Claeys, Konstantinos Efstathiou and Dirk Schoenmaker Topic: European Macroeconomics & Governance Date: October 18, 2017
Read about event More on this topic

Upcoming Event

Oct
26
14:30

Growth, productivity and social progress in Europe

On 26 October, Bruegel is organizing an interactive brainstorming seminar on Growth, Productivity and Social Progress in Europe. This is a closed-door, high-level workshop for a selected number of experts in the field.

Speakers: André Sapir Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic

Past Event

Past Event

Financial Stability Conference 2017

EU at Crossroads: How to respond to Misalignments in Bank Regulation and achieve a consistent financial Framework?

Topic: Finance & Financial Regulation Location: Berlin, Germany Date: October 15, 2017
Read about event More on this topic

Upcoming Event

Nov
6
12:30

An independent assessment of the EU's fiscal framework: presentation of the first annual report of the European Fiscal Board

This event will feature a presentation of the first Annual Report of the European Fiscal Board.

Speakers: Mateusz Szczurek, Niels Thygesen and Further speakers to be confirmed Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article

Blog Post

An update: sovereign bond holdings in the euro area – the impact of quantitative easing

Since the European Central Bank’s announcement in January 2015 of its quantitative easing programme, national central banks have been buying government and national agency bonds. In this post we look at the effect of QE on sectoral holdings of government bonds, updating calculations that we published initially in May 2016.

By: Pia Hüttl and David Pichler Topic: European Macroeconomics & Governance Date: October 10, 2017
Read article

Blog Post

India’s trade ties with the UK and EU

As EU and Indian leaders meet in Delhi, we look at the figures on trade. The UK’s place in the relationship warrants special attention. EU-India trade has more than tripled since 2000, but UK-India trade is largely static. The shift is especially noticeable for EU exports to India, where the UK share has dropped from 29% to 10%.

By: Maria Demertzis and Alexander Roth Topic: European Macroeconomics & Governance, Global Economics & Governance Date: October 6, 2017
Read article More on this topic More by this author

Blog Post

Catalonia and the Spanish banking system

As tensions rise around Catalonia's independence movement, there are worries about the impact on the Spanish banking sector. Banks based in Catalonia account for around 14% of total assets. Some major institutions are already moving their headquarters to other parts of Spain. However, most Spanish banks have significant exposure to the Catalan market, and all could be caught up in the turmoil.

By: Yana Myachenkova Topic: European Macroeconomics & Governance Date: October 6, 2017
Read article More on this topic

Blog Post

What has driven the votes for Germany’s right-wing Alternative für Deutschland?

The AfD vote in East Germany was consistently stronger than in the West, even after controlling for income, age, education, religion and the overall rural nature of the new Bundesländer.

By: Alexander Roth and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: October 5, 2017
Read about event

Upcoming Event

Nov
28
12:30

Sustainable growth in transition countries

This event will feature a presentation of the EBRD Transition Report 2017-18.

Speakers: Jonathan Charles, Zsolt Darvas, Jean Pisani-Ferry, Sergei Guriev and Debora Revoltella Topic: European Macroeconomics & Governance, Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article Download PDF

External Publication

European Parliament

The single monetary policy and its decentralised implementation: An assessment

This paper assesses the decentralised implementation of monetary policy by the Eurosystem in terms of its transparency, efficiency and simplicity. Compared to the Fed, the Eurosystem seems to have higher staff numbers and operational costs for similar tasks.

By: Francesco Papadia and Alexander Roth Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: October 4, 2017
Read article More on this topic More by this author

Blog Post

Ukraine’s oligarchs are bad for democracy and economic reform

Ukraine’s late and incomplete economic reform created a class of super-wealthy oligarchs who now stand in the way of further liberalisation. The oligarchs’ oversized influence only deepens public distrust in a structurally weak political system. Nevertheless, Ukraine is making some attempts to uproot corruption and the next steps are clear.

By: Marek Dabrowski Topic: European Macroeconomics & Governance Date: October 3, 2017
Load more posts