The Italian Banking System in the Perspective of the Banking Union Fabio Panetta Member of the Governing Board - Banca d’Italia London, November 21, 2013
Outline of the Presentation 1. The Banking Union (BU) project o the Single Supervisory Mechanism (SSM) o the Balance Sheet Assessment (BSA) 2. The Italian banking system in the perspective of the SSM o a bird’s eye view on the current state of affairs o credit quality, capital and profitability o the Bank of Italy’s supervisory action 3. Summary assessment & outlook
The Banking Union in the Euro Area o What is the BU? o A Single Supervisory Mechanism (SSM) by the ECB & NSAs o A Single Resolution Mechanism (SRM) o A harmonized deposit guarantee system o Financial backstops and bank recapitalization at the EU level o Why a BU in the Euro Area? o Break the perverse banks/sovereigns feedback loop o Preserve the Single Market, avoid fragmentation o Empower a supranational supervisor for large, cross-border banks
The SSM: Coverage, Timeframe o Mandatory for EA countries, open to other EU countries o ECB will directly supervise 130 large banks ( TA>€30bn or TA>20% of domestic GDP) o NSAs will supervise the remaining 6,000 banks following common guidelines o SSM will be operational in Q4-14 o From Q4-13 to Q3-14 ECB & NSAs will conduct a comprehensive assessment – including a balance sheet assessment (BSA) and a stress test (ST)
The BSA: a Key Step of the BU Process o Exercise must be credible and rigorous, in order to: o restore full confidence on banks’ soundness o enhance transparency of their balance sheets o This requires putting banks on a level playing field (eg using severe/homogeneous definitions of NPLs) and reaching opaque corners of balance sheets (L3 assets, derivatives, etc.) o Possible follow-up includes recapitalisation o Viable banks should be recapitalised first of all by private investors (no bail-outs)... o ... but public backstop will be available upfront (otherwise the credibility of the exercise might be put at risk) 5
Italian Banks and the BU o The BU will bring straight benefits to Italian banks by: o reducing market fragmentation, thus improving funding conditions o increasing transparency, hence comparability of balance sheets o breaking the link between sovereign risk and bank risk o Italian banks are ready for the BU and the BSA
Italian Banks and the BU o The BU will bring straight benefits to Italian banks by: o reducing market fragmentation, thus improving funding conditions o increasing transparency, hence comparability of balance sheets o breaking the link between sovereign risk and bank risk o Italian banks are ready for the BU and the BSA o The above arguments, however, are NOT meant to downplay the risks that the Italian banking system faces
Banks’ Key Problem: Rising Credit Risk 21 o Credit quality is 19 NPLs and bad loans of Italian banks (% of loans) deteriorating, driven by 17 15 loans to non-financial 13 NPLs corporations (NFCs). 11 9 HHs more resilient 7 Bad loans 5 3 2006 2007 2007 2008 2008 2009 2009 2010 2010 2011 2011 2012 2012 2013 o Gross (operating) profits Profitability and Provisions of Italian Banks have resumed growth in (billion euros) 40 2012 (but 2013 results like- Operating Profits ly affected by low rates). 30 o The increase in provisio- ning is eating up a large 20 Provisions and Net Value Adjustments part of gross profits. Net for Loan Impairment profitability is low 10 2008 2009 2010 2011 2012
Banks’ Key Problem: Rising Credit Risk (2) Flows of new NPLs: Firms o Gross operating profits sufficient to cover loan loss provisions in 2013 and 2014 New NPL rate o The flow of new NPL and of New bad bad loans to NFCs are sho- loan rate wing signs of a turnaround.
Italy’s Classification Standards Are Rigorous: Credit Risk May Look Larger Than it is NPL ratio of Italian banks (% of loans) o Italian banks follow prudent 14 December 2012 supervisory standards 12 o If Italian banks followed the 10 standards used in other Accounting Accounting 8 and and supervisory jurisdictions (e.g. excluding supervisory standards of 6 standards of Italian banks large European fully-collateralized NPLs) then: banks 4 2 o the NPL ratio would be 1/3 lower 0 Coverage ratio of Italian banks (% of NPLs) o coverage ratios would be 60 higher by 20 pct. points December 2012 50 o NPL definition proposed by 40 EBA is in line with (or less 30 comprehensive than) Italy’s Accounting Accounting and and supervisory supervisory definition. standards of 20 standards of large European Italian banks banks 10 0
Stock of NPLs Will Have to Be Reduced o Market for assets securitization very thin. Price differential between supply and demand of NPL large but likely to narrow: o The Bank of Italy’s recent action on value adjustments o Reduced financial market fragmentation (economic recovery, SSM comprehensive assessment) o The Stability Bill for 2014 provisions on tax treatment of loan losses and value adjustments
Banks’ Holding of Sovereign Bonds Purchases of sovereign bonds by Italian banks o Large purchases of domestic sovereigns over 2 years. a. ample differential sov’s vs loans b. precautionary demand c. fragmentation o In last 3 months sov. portfo- lio shrank (€10bn), due to improvement in (a), (b), (c). Italian sovereign bonds of non-residents o The conditions of sovereign markets are improving. Not just rates and spreads: foreign holdings are increasing.
BUT the system has several points of strength Capital Positions Continue to Improve Top 5 Banking Groups Other Banks 13% 17% o Capital ratios have 15% Total Capital Ratio increased continuously Total Capital Ratio 13% 11% 11% since 2008, as a result of 9% Core Tier 1 Core Tier 1 both capital issues and 7% lower RWAs. 5% 9% 2008 2009 2010 2011 2012 2013 2008 2009 2010 2011 2012 2013 (June) (June) Bank capital injections by the public sector in selected countries (bn. euros) o The amount of public funds injected into the banking system by the Italian State is very low. Italy: 0,3% of GDP
Retail Funding Continues to Grow Retail Funding and Funding Gap o The system is retail-based 25 Funding Gap as a Percentage of Loans o deposits continued 20 their steady growth 15 throughout the crisis 10 o the funding gap is low 5 Retail Funding (12 month pct growth) and declining 0 -5 Mar 03 Mar 04 Mar 05 Mar 06 Mar 07 Mar 08 Mar 09 Mar 10 Mar 11 Mar 12 Mar 13
Liquidity Conditions and Eurosystem Borrowing Composition of Italian Banks' Funding 100% o Overall liquidity position is satisfactory 75% o Dependence on ECB fun- 50% ding significant but falling 25% o banks (especially large ones) have regained access 0% Dec - 2008 Dec - 2010 Dec - 2012 Jun - 2013 to wholesale markets Retail Wholesale Eurosystem refinancing Availability of Collateral for Italian banks o Available eligible assets continue to increase 302 334 o Ongoing work to make bn . bn. revolving loans (an Italian feature) and pools of loans pledgeable
Leverage is Low and Declining EU Banks' Leverage 30 o Banks are deleveraging. 25 Credit growth is negative, mainly in response to weak 20 loan demand by NFCs 15 o Leverage (total assets / 10 tier1 capital) is low by 5 international standards 0 AT BE DK FR DE IT NL UK ES SE EU Level 3 assets of European banks (%) o Level 3 assets are negligi- ble
Supervisory Action by Banca d’Italia Capital strengthening has been driven by o supervisory pressure Ad hoc action on provisioning initiated in 2012, o also by running targeted on-site inspections Intensified off-site monitoring o Pressure on cost cutting and restructuring (i.e. o disposing of non-core assets)
Capital Needs: the FSAP of the IMF IMF FSAP estimates of cumulated capital shortfall (billion euros) CET 1 T 1 Scenarios # of failing # of failing capital shortfall capital shortfall banks banks €bn % of GDP €bn % of GDP Baseline (at end-2017) 5 1.0 0.1 10 3.4 0.2 Low growth (at end-2017) 11 4.9 0.3 15 10.2 0.7 Adverse (at end-2015) 13 6.0 0.4 20 13.8 0.9 Capital benchmark: Basel 3 phasing in for both CET1 and T1. o IMF (FSAP, Sept. 2013): 32 banks, individual data: o capital need in stressed conditions €bn. 6.0-13.8 (0.4-0.9% GDP) o shortfalls mainly in small-medium local banks o Estimates of private analysts: based on heterogeneous (sometimes simplistic!) hypotheses and methodologies, but results are of similar magnitude
Summary Assessment & Outlook o The Italian banking system has shown strong resilience in the face of an exceptional economic crisis o A successful, gradual exit from currently stressed condition is possible o SSM and BSA are not a further problem. They are part of the solution
Summary Assessment & Outlook o Economic recovery after a double dip recession is the critical success factor for Italian banks. It is a precondition to start reduction of the stock of nonperforming loans and to restore profitability. o Expectations for key ECB interest rates to remain low for as long as necessary provide support to recovery o Continuing national efforts at reform of the economy and consolidation of public finances are key
Thank you!
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