The Bank of Italy s Financial Stability Report The

The Bank of Italy’s Financial Stability Report: The Italian economy moving forward? Sergio Nicoletti Altimari Bank of Italy – Financial Stability Unit Roma, 30 November 2011 1

The macro-financial context Ø A sudden worsening of the outlook for global growth since last summer has heightened fears for the soundness of heavily indebted borrowers, public and private alike Ø Concerns are emerging that the phase of weakness will persist, in particular as a consequence of the deleveraging process of the public (necessary consolidation measures) and private sectors (banks, but also households and firms; Figure) Ø The sovereign debt crisis in Europe has spread to Italy and Spain; other countries are also coming under stress (Belgium and, lately, even France; tensions are emerging for Austria; Figure). Ø The difficulties encountered by the authorities at the national and supranational level in implementing suitable countermeasures are playing a significant part 2

The Italian situation Ø The increase in risk aversion has hit especially those countries with a high public or private debt. For Italy, key weaknesses are high public debt, track record of poor growth performance Ø But Italy can count on a series of strengths: 1. Steady trend towards consolidation of public accounts 2. Relatively low level of foreign debt 3. No clear signs of imbalances in the real estate markets 4. Low level of private debt 5. Overall sound banking system 3

1. Fiscal consolidation Ø Italian fiscal policy during the crisis has been prudent. The government did not have to intervene to bail out banks. Ø Italy among very few countries with a primary surplus. New measures will be necessary to reach a balanced budget in 2013. Public debt/GDP ratio should start declining in 2013 (2012 in governments’ estimates; Table) Ø Forward-looking indicators of fiscal sustainability that take into account the increase in age-related expenditures are relatively favorable (thanks to pension reforms since mid 1990 s) (Table) Ø Thanks to the long duration of its debt (over 7 years), and provided that public finance targets are fully met, Italy’s debt-to-GDP ratio should decline or stabilize over the next three years even if interest rates were to undergo a further, sharp increase (Figure) 4

2. Relatively low level of foreign debt Ø Italy’s net international investment debtor position is 24% of GDP, higher than euro area average (13%), but well below that of the euro area countries under stress (Table) Ø Italy’s balance of payments has worsened since the mid-90 s mainly on trade, owing to a progressive loss of competitiveness. Ø But exports have been one of the main determinants of growth. Our estimates indicate that the current account deficit should diminish considerably in the next years. Fostering Italian competitiveness remains a priority 5

4. Private sector: Households Ø Italian households are financially sound. Total net wealth is 8 times disposable income; gross financial wealth is 3. 4 times. Debt is modest: 66% of disposable income (around 100% in the euro area; 120% or more in the US and the UK (Figure) Ø 70 per cent of outstanding mortgages are at variable rate, linked to the Euribor, which is supposed to decrease in the next months. Ø Spreads on new mortgages are increasing reflecting the higher cost of bank funding. However, the share of household loans that are going to expire in the next two years is relatively low (less than 30%) Ø Problems may emerge for low-income indebted households; risk for banking system are however limited, as these households hold a very limited portion of bank loans (10 -12% of the total) RISKS are overall low

4. Private sector: Non-financial firms Ø Italian firms’ financial debt is relatively low (Figure) Ø However, the weakening of economic activity is taking its toll: Ø In June 2011 gross operating profit grew by 1. 4% (3. 3% last December). Ø Borrowing requirement rose, as growth in self-financing failed to keep pace with that in capital spending Ø Business surveys point to expectations of a decline in activity and a worsening of credit conditions. Ø Italian firms are vulnerable to interest rate risk, owing mainly to the high proportion of short-term debt (some 60 per cent of their debts to banks have a maturity of less than two years), Ø KEY RISKS are due to a decline in activity and to tighter bank lending conditions due to current strains in bank funding

5. Banks: funding & liquidity Ø Sovereign debt crisis is affecting European banks: widening of CDS spreads. Exposure to weak sovereign very limited. However, exposure to the national sovereign is large (Table). CDS exposure is negligible (Figure). Ø Impact on cost and availability of wholesale funding. Increasing refinancing at the Eurosistem. However, Italian banks’ funding with retail customers (least sensitive to market movements) is high if compared with other euro area banks (Figure) Ø Major Italian banks’ refinancing needs in 2012 (24% of the bonds outstanding) in line with average for large banks in Europe (Figure). Ø Economic slow-down clouds the outlook for credit quality, notwithstanding signs of amelioration in 2011. Ø KEY RISKS: Refinancing risk, shutdown of wholesale markets (common to Europe); sovereign risk. Problems: low profitability 8

5. Banks: capital Ø Significant fresh capital injections ahead of the July European stress tests. Strengthening is proceeding further, in line with EBA initiative (major European banks must reach a 9% Core tier 1 ratio by June 2012, after taking into account sovereign exposures). Ø Italian banks’ leverage (total assets/Tier 1 capital) is lower than the European average (19 vs 29) Ø Core tier 1 ratio for the largest 14 banks stood at 8. 5% in June 2011 (7. 5% in Dec 2010). Unicredit has recently announced a capital increase of 7. 5 billion euros. Ø Measures agreed at the European level are part of a package that will include public guarantees schemes on medium-term funding. Ø Looking ahead, recouping profitability is key in order to further strengthen banks’ capital positions. 9

Conclusions Ø Global tensions have affected Italy is suffering from high public debt and low growth, but has a series of strengths (prudent fiscal policy, low private debt, no real estate bubbles, limited foreign debt) Ø The Italian banking system is not a source of instability. Banks’ capital position significantly strengthened in 2011. This action is proceeding further, in parallel with European initiatives Ø Italian banks are affected by the sovereign debt crisis. Exposure to program countries is very limited, but exposure to domestic sovereign is sizeable. Tensions in liquidity and access to market funding, in line with other European banking systems Ø To overcome sovereign crisis and preserve financial stability: Ø Further fiscal consolidation Ø Credible policies for sustained economic growth Ø Initiatives at the EU level 10

Deleveraging in the private sector Private sector debt Households Nonfinancial companies (% of disposable income) (% of GDP) (BACK)

Figure 2 10 -year interest rates in the euro area Source: Bloomberg. (BACK)

Financial sustainability indicators (BACK)

Financial sustainability indicators 14 (BACK)

Financial sustainability indicators 15 (BACK)

Financial sustainability indicators 16 (BACK)

The dynamics of Italy’s public debt (BACK)

The real estate market in Italy House prices and sales (indices, 2005=100) (BACK)

The real estate market in Italy Affordability of housing and ratio of house prices to rents (semi-annual data; indices, 1992/2009 average =100) (RHS) (LHS) (BACK)