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.

Read article Download PDF More on this topic More by this author
 

Policy Contribution

Emerging Europe and the capital markets union

The European Union's capital market union needs a revamp because of Brexit and the deep recession, and to underpin the European Green Deal. In particular, equity capital in the countries of central and eastern Europe is underdeveloped. These countries should take measures to facilitate equity finance, accompanied by reform at EU level.

By: Alexander Lehmann Topic: Finance & Financial Regulation Date: September 17, 2020
Read article More on this topic More by this author
 

Blog Post

Private equity and Europe’s re-capitalisation challenge

Companies are struggling in the coronavirus crisis but solvency support provided by the European Union looks likely to be modest. This will make private equity more important in the recovery, and could create a springboard for longer-term reform to boost private equity.

By: Alexander Lehmann Topic: Finance & Financial Regulation Date: September 17, 2020
Read article More by this author
 

Blog Post

Unpacking President von der Leyen’s new climate plan

European Commission President Ursula von der Leyen has set a new destination for EU climate policy: a 55% emissions reduction by 2030. This is a good and necessary step on the way to climate neutrality by 2050, but getting there will not be easy, and Europe should prepare for a bumpy road ahead.

By: Simone Tagliapietra Topic: Energy & Climate, European Macroeconomics & Governance Date: September 16, 2020
Read article More on this topic More by this author
 

Podcast

Podcast

The State of the Union going forward

In the first Sound of Economics Live episode after summer we look at the State of the Union address delivered by Ursula von der Leyen.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: September 16, 2020
Read about event
 

Past Event

Past Event

The Sound of Economics Live: The State of the Union going forward

In the first Sound of Economics Live episode after summer we look at the State of the Union address delivered by Ursula von der Leyen.

Speakers: Giuseppe Porcaro, André Sapir, Guntram B. Wolff and Alicia García-Herrero Topic: Energy & Climate, European Macroeconomics & Governance, Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: September 16, 2020
Read article More on this topic More by this author
 

Opinion

Without good governance, the EU borrowing mechanism to boost the recovery could fail

The European Union recovery fund could greatly increase the stability of the bloc and its monetary union. But the fund needs clearer objectives, sustainable growth criteria and close monitoring so that spending achieves its goals and is free of corruption. In finalising the fund, the EU should take the time to design a strong governance mechanism.

By: Guntram B. Wolff Topic: European Macroeconomics & Governance Date: September 15, 2020
Read about event More on this topic
 

Upcoming Event

Sep
28
15:00

From playing field to player: Europe’s strategic autonomy as our generation’s goal

At this online event Charles Michel will speak the importance of Europe's strategic autonomy.

Speakers: Charles Michel and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article Download PDF More on this topic
 

Policy Contribution

Financing the European Union: New Context, New Responses

With the European Union for the first time taking on debt to help finance the economic recovery from the coronavirus, new resources are needed to fund the EU budget. Various ideas have been floated – including a digital tax and a financial transactions tax – but the most appropriate new resource would be revenues from the EU emissions trading system, which could provide enough funding to repay the EU's coronavirus borrowing.

By: Clemens Fuest and Jean Pisani-Ferry Topic: European Macroeconomics & Governance Date: September 11, 2020
Read article More by this author
 

Podcast

Podcast

For a better, more sovereign Europe

Keynote address by the German Federal Minister of Finance Olaf Scholz at Bruegel Annual Meetings, 3 September 2020

By: The Sound of Economics Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: September 9, 2020
Read article More by this author
 

Parliamentary Testimony

Employment and COVID-19

Testimony before the Economic Affairs Committee at the House of Lords, British Parliament on Employment and COVID-19.

By: Guntram B. Wolff Topic: European Macroeconomics & Governance, Finance & Financial Regulation, Testimonies Date: September 9, 2020
Read about event
 

Past Event

Past Event

Bruegel Annual Meetings 2020 - Day 3

Third day of Bruegel Annual Meetings.

Topic: Energy & Climate, European Macroeconomics & Governance, Finance & Financial Regulation, Global Economics & Governance, Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: September 3, 2020
Read about event
 

Past Event

Past Event

Bruegel Annual Meetings 2020 - Day 2

Second day of Bruegel Annual Meetings.

Topic: Energy & Climate, European Macroeconomics & Governance, Finance & Financial Regulation, Global Economics & Governance, Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: September 2, 2020
Load more posts