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Testimony of Mr Fabrizio Saccomanni, Director General of the Bank of Italy, before the Finance Committee of the Chamber of Deputies, Rome, 15 September 2009. | Fabrizio Saccomanni: Fact-finding for the examination of the Communication of the European Commission on European financial supervision Testimony of Mr Fabrizio Saccomanni, Director General of the Bank of Italy, before the Finance Committee of the Chamber of Deputies, Rome, 15 September 2009. * 1. * * Introduction The financial crisis has shown the need to strengthen regulation and supervision and to intensify cooperation between national authorities worldwide. In Europe, this effort must be supported by a revision of the institutional arrangements for supervision: markets have become considerably more integrated and an important role is played by large and complex intermediaries with important interests in a number of different countries; financial stability cannot be preserved exclusively by the exercise of powers and responsibilities assigned at the national level. In the last decade there has been a serious effort to harmonize community legislation. Between 2001 and 2004 the establishment of three so-called “level 3” committees to provide technical support to the Commission and to collaborate with national authorities in the area of banking (CEBS), insurance (CEIOPS) and securities (CESR) has brought about closer cooperation between the authorities and has enhanced the convergence of supervisory practices. During their first few years the Committees drew up numerous guidelines for the uniform application of community regulations in their respective fields; they introduced their own internal procedures to monitor compliance with common standards in the member states and to resolve disputes between national authorities; they supported the establishment of colleges of supervisors and developed common practices to encourage the efficient organization of controls on cross-border banking groups. Although substantial, the results achieved are not enough. The rules still vary considerably from country to country. The directives contain too many options and national discretions; even in the absence of explicit discretionary powers, transposition into national law has allowed the regulations to be interpreted in many different ways. The result is that the rulebook according to which a cross-border group must operate is a collection of national texts that differ significantly from one another even in the harmonized areas. National supervisory practices reflect the institutional arrangements and the different traditions of the local authorities. The common rules are filtered through very different approaches to their application. For example, the crisis has shown that harmonized rules on the definition of capital, on securitization and on the consolidation of structured investment vehicles (SIVs) have been applied in very different ways by different countries – in Italy the approach has been rigorous and prudent, but attitudes in other countries are much less restrictive. The colleges of supervisors, which bring together the authorities responsible for the supervision of cross-border groups, have not played a pivotal role during the crisis and have basically remained simple centres for exchanging information; only in a few cases has there been a real coordination of the risk assessments and of the joint definitions of the priority areas for supervisory interventions. Discrepancies in the nature and powers of the authorities as well as in the instruments for resolving crises have in practice prevented any real coordination of the actions taken by the single authorities. The tendency to resort to national solutions has been further accentuated by the absence of principles agreed at the European level on the distribution among the member states of the financial costs associated with supporting banks in difficulties. 2. The reform of the European supervisory system The European Commission has recognized that a supervisory system divided along national lines would find it difficult to prevent and manage crises of a systemic nature. As a result, in October 2008 it mandated a group of high-level independent experts, chaired by Jacques de Larosière, to present some proposals for reform. In particular, the group was asked to consider how to strengthen European cooperation in monitoring risks to the financial stability of the entire system i.e. macroprudential supervision. In effect, the financial crisis has shown that the soundness of individual institutions is not, by itself, sufficient to ensure the stability of the financial system. It is also fundamental to take account of the influence that common risks may have on the system overall; to assess the interactions between the behaviour of single institutions, between the different markets and between finance and the real economy; and to identify the channels through which crises could be propagated. For years numerous central banks, including the ECB, have performed analyses on financial stability conditions. Often, they have identified risks that subsequently materialized, but they have lacked the instruments for translating their findings into concrete intervention policies. The mandate of the de Larosière group was to study how best to organize micro-prudential supervision of European financial institutions in order to overcome the limitations of an approach that relies solely on voluntary cooperation among national regulators. The de Larosière Report proposes a reform resting on two main pillars. The first relates to macro-prudential supervision, which would be entrusted to a new body, the European Systemic Risk Board, or ESRB. The second pillar concerns micro-prudential supervision, to be governed by a European System of Financial Supervisors (ESFS) consisting of three new European authorities in charge of separate areas of financial intermediation (banking, insurance, and securities), the colleges of supervisors and the national supervisory authorities. The Report’s recommendations were adopted by the European Commission, which issued a Communication on 27 May this year outlining the main points of the reform and setting out a plan of action to make the new architecture operational by the end of 2010. The Commission’s proposals were broadly endorsed by the Ecofin Council of 9 June and by the Council of Heads of State and Government of 19 June. The Commission will put forward its legislative proposals at the end of September, the texts of which should be approved in time to make sure that the new system is up and running in 2010. In the plan approved by the Council, the ESRB will be assigned to carry out studies on the European financial system in order to issue warnings concerning particular areas of risk and vulnerabilities in the financial structures requiring the authorities’ attention. It will then draw up non-binding recommendations for corrective action at European or national level, which will be channelled through the ESFS and the Ecofin Council. Lastly, it will monitor the effective implementation of its recommendations. As regards organization and functioning, the ESRB will not be an independent legal entity; it will be composed of the governors of the national central banks of the 27 member states, the chairpersons of the three new European Supervisory Authorities, and a representative of the European Commission. A representative of the national supervisory authority of each member state and the President of the Economic and Financial Committee of the European Union will participate as non-voting observers. The ESRB will be chaired by the governor elected by the members of the General Council of the ECB; the ECB will provide analytical, logistics and administrative support to the ESRB, which will have a Steering Committee comprising the chairperson and vice-chairperson, the governors of two national central banks (one from the euro area and one from a non-euro country), the Commission representative, and the President of the Economic and Financial Committee. For micro-prudential supervision the reform will institute the European System of Financial Supervisors (ESFS), in which the CEBS, CEIOPS and CESR will be transformed into European Supervisory Authorities (ESAs) with legal personality under Community law. The new system will continue to envisage the decentralization of supervisory powers, which remain with the national authorities and the colleges of supervisors set up for cross-border groups, while a number of important functions will be centralized within the ESAs. More specifically, the ESAs 1) can issue binding technical standards to ensure that national supervisory authorities follow uniform and consistent approaches and develop a common rulebook applicable to all financial institutions in the European Union; 2) will be empowered to adopt binding resolutions to settle disagreements between national authorities on issues concerning cross-border supervision; 3) will perform tasks of coordination of supervisory activities, including within the colleges of supervisors; 4) will be directly responsible for overseeing the rating agencies; and 5) will set up and manage common databases for information exchanges with the ESRB for purposes of macro-prudential supervision. As regards organization, the Commission’s Communication states that the Board of Supervisors of each ESA should be comprised of high-level representatives of the supervisory authorities of the EU member states. Representatives from the ESBR, the Commission and the relevant supervisory authorities from EEA countries will take part in the Board as observers but would not be able to attend any discussions of confidential matters pertaining to individual institutions. The chairpersons and executive directors of the European Supervisory Authorities should be full-time independent professionals rather than representatives of the national supervisors as was the case with the Level 3 committees. The European Commission has proposed that a Management Board also be set up, where appropriate, which would be composed of a small number of representatives of the national supervisors and a representative of the Commission. 3. Issues in implementing the reform The institutional framework outlined in the reform proposals boasts several merits. It is important, however, to take an ambitious and unambiguous approach to putting this reform into practice. I would like to consider six aspects that I believe are crucial to success: (1) the ESRB’s structure and tools; (2) the independence of the new bodies; (3) the creation of a single rulebook and the establishment of common supervisory approaches; (4) the gathering and sharing of confidential data; (5) the colleges of supervisors; and (6) the legislation and agreements on crisis management. 3.1 Structure, powers and tools of the ESRB (i) An institutional framework centred on the central banks. The national central banks are generally assigned a leading role in ensuring national financial stability. In pursuing the goal of monetary stability the central banks necessarily also consider the aspects relating to financial stability; in the case of the ECB this is recognized in specific provisions of the European Treaty (e.g. Article 105(5)). In view of their institutional competences the NCBs have developed the capabilities, skills and toolkits needed to analyze the stability of the financial system. The new Board must, from its inception, be firmly anchored to the ECB in order to benefit from the latter’s well-established reputation and the direct contribution of the specialist technical and operational know-how needed to monitor the financial stability of the EU area. Appointing the President of the ECB as chairperson of the ESRB would help to guarantee the adoption of a consistent approach in pursuing monetary stability and safeguarding the stability of the system. The legal basis for the ESRB will be Article 95 of the Treaty, but it would be advisable to consider appealing also to Article 105(6), under which the ECB can be assigned specific tasks in respect of prudential supervision, so that the institutional nature of the link between it and the ESRB and the modalities of the ECB’s involvement in the latter’s activities may be established clearly and with the appropriate guarantees. (ii) Linkage with micro-prudential supervision. Macro-prudential supervision by the ESRB can be effective only if the analyses and assessments of the risks to financial stability serve to orient the priorities of micro-prudential supervision on intermediaries and financial markets. Coordination between the ESRB and the ESAs needs to be very strong even in the analysis phase, so as to ensure a sharing of approaches and speedy and efficient exchange of information. In particular, risk assessment should be based on the extensive direct involvement of the colleges of supervisors. If the aim is to have the results of macro-prudential analyses used in the supervision of financial groups, the colleges must be able to contribute actively to identifying the main risk factors and the policy options. On the other hand, the ESRB must be in a position to acquire the micro-prudential information necessary for analysis of the risks, with a special focus on large banks. The exchange of information between the European Supervisory Authorities and the ESRB should be governed by a protocol of cooperation, so as to ensure observance of the rules on the confidentiality of supervisory data. When highly confidential information is involved, it could be sent in anonymous form. (iii) Effective macro-prudential instruments. The ESRB’s main instrument will be the power to send recommendations to the competent authorities. Separation between the entity that identifies the risks and issues the recommendations and those that control the policy instruments bearing on financial institutions and markets could give rise to confusion in the assignment of responsibilities and to misalignment of incentives. On the one hand, the ESRB’s recommendations should be formulated at EU-wide level or possibly refer to specific categories of intermediary or groups of countries but not to individual institutions, in order to avoid confusion of competences with the national authorities that supervise those institutions. On the other hand, the mechanisms for the enforcement of the recommendations must be particularly stringent. The Communication of the Commission envisages that if the national authorities decide not to follow a recommendation or to follow it only in part, they must give a public explanation for their reasons (“act or explain”). This also implies that the recommendations of the ESRB should normally be given adequate publicity. The direct assignment of some instruments to the ESRB could also be considered. For example, in the international discussion there is agreement on the need to introduce countercyclical prudential instruments that encourage the formation during expansions of buffers to be used in recessions or market crises, when the risks materialize. The ESRB could have a direct role in the design and maintenance of these instruments. 3.2 Independence, governance and accountability (i) Independence of the ESRB and involvement of the political authorities. Anchoring the ESRB to the ECB should provide sufficient guarantees of the institutional independence of the macro-prudential supervisory function. Indeed, it has been argued that this independence might be excessive, given the responsibilities that governments also have regarding financial stability. However, the institutional arrangement proposed by the Commission strikes an appropriate balance between the different interests. The involvement of the political authorities is ensured through the participation of the chairman of the EU Economic and Financial Committee in the ESRB as an observer. In addition, the fact that the ESRB submits its recommendations to the Ecofin Council will ensure the governmental involvement and commitment essential to their implementation. (ii) Independence of the ESFS. By comparison, the safeguards for the independence of the ESFS appear less sturdy. The de Larosière Report, the Communication of the Commission and the Conclusions of the Council underscore that its independence is essential to the success of the reform, but the legal basis for the new authorities will consist solely in Article 95 of the Treaty, which according to the practice followed to date assigns the Commission strong influence over the functioning of European agencies. The implementing texts must give the ESAs sufficient autonomy in issuing supervisory standards and prevent these from being operationally dependent on the Services of the Commission. Without amendments to the Treaty, regulatory powers cannot be assigned directly to the ESAs. But the process of approval by the Commission of the standards issued by the ESAs must not actually diminish the authorities’ role and their responsibility regarding rules of a more technical nature. In particular, the Commission should not be allowed to approve the texts proposed by the ESAs only in part or to modify them; otherwise, the Commission would become the supervisory standard setter and the ESAs would be relegated to a role of technical assistance. The Lisbon Treaty provides for two categories of secondary legislation at Community level: delegated regulations and implementing measures. For the latter, which are inherently more technical, there could be a further delegation to the ESAs. The Commission could approve by the “non-opposition” formula, similar to the mechanism used to introduce the accounting standards issued by the International Accounting Standards Board into Community legislation. Under the Treaty, in the cases where the ESAs are considered to have overstepped their bounds in interpreting the delegation or have issued rules inconsistent with the first-order principles, the Commission and the co-legislators, the European Council and Parliament, can revoke the regulations issued by the ESAs and legislate at a higher level – either with primary legislation or with a delegated regulation, assigned to the Commission with the support of high-level committees of member states. (iii) Governance of the ESAs. The chairpersons and executive directors of the ESAs must be selected through appointment procedures that safeguard their independence, for example with “confirmation” by the European institutions. The Commission should participate in the authorities’ decision-making as an observer. The Commission should be excluded from the management boards and – in contrast with what is proposed in the Commission’s Communication – also from the Steering Committee that is to coordinate the actions of the three ESAs. This would also ensure compliance with the requirement of confidentiality in the exchange of supervisory information between the authorities. The authorities should have an autonomous budget, but, in the light of the important standard-setting tasks delegated by the Commission, provision could be made for substantial resources drawn on the EU or Commission budget. It will be necessary, lastly, to establish appropriate procedures for the authorities’ accountability to the European institutions and to clarify the mechanisms for the enforcement of the agencies’ decisions and the procedures for appeals. 3.3 Single rulebook and uniform supervisory approaches (i) Truly homogeneous supervisory rules and standards in the single market. The Communication of the Commission and the Conclusions of the Council leave room for highly disparate interpretations of the notion of single rulebook. In a minimalist reading, the main step could be held to lie in the elimination of options and national discretions from the directives. Instead, it is fundamental to significantly expand the scope of the supervisory rules and standards issued at European level and directly applicable to financial institutions by reducing to a minimum the margins for introducing differences through the process of transposition into national legislation. Ideally, the set of rules that apply to a financial institution authorized in the European Union should consist largely of directly applicable European rules and only residually of measures adopted at national level in order to take account of the specificities of local markets. However, there is no blinking the fact that the single rulebook will be drafted starting from a multiplicity of legal orders and supervisory systems, with divergent characteristics. On financial regulation, in some EU countries a good part of the rules are laid down by sectoral authorities, while in others the national rulebook consists largely in legislation. Italy is somewhere in between: although we have opted for a significant narrowing of the scope of legislation, the regulatory functions are exercised by Italian supervisory authorities under principles and criteria set by law or ministerial decree. As for controls, there are radical differences from country to country in the relative importance of off-site analysis and on-site inspection and in powers of access and verification at intermediaries. The drafting of the single rulebook will therefore take time. But it is a good thing to specify the stages of the process from the very outset. (ii) Ample use of binding standards in all the more technical matters. Going by the Ecofin Council conclusions, the ESAs can lay down standards for the matters to be specified in Community legislation. From the first stage of implementation of the reform, Community legislation could assign the new European authorities the task of setting standards in the areas with the greatest technical content. In banking, for instance, the new authority could be empowered to issue binding standards on the definition of capital, capital requirements, risk concentration, limitation of liquidity risk, prudential reporting, methodologies and procedures for prudential controls, and the practical operation of colleges of supervisors. These are areas that have little impact on the fundamental principles and rules of national law, and in which current divergences often stem from the difficulty of abandoning established practices. However, there are other sectors in which convergence is less apt to proceed by means of standards laid down by the newly constituted European authorities. Such aspects as the powers of supervisory authorities over market entry and exit, intermediaries’ governance and internal controls, and sanctions affect each nation’s normative and institutional arrangements more substantially and so require specific national rules for implementation. These parts of the rulebook may well continue to be governed at Community level by the traditional instrument of the directive, albeit one for maximum harmonization. (iii) Convergence on a high level of prudential rigour in standards and application. Finally, turning to the substance of the single rulebook, it is important that convergence not be pursued at the expense of the efficacy of rules and controls. We must prevent the difficulties of reaching agreement among such different approaches from resulting in the adoption of accommodating standards and supervisory practices – a sort of lowest common denominator. Rather, the European rulebook should look to the rules and supervisory models of the countries whose financial systems have proven most robust – those least exposed to the causes and consequences of the crisis, thanks to strict and particularly risk-sensitive supervisory practices. In our view, this crisis shows that the Italian supervisory model can provide a useful point of reference for the process of convergence. It will be just as important to develop strict, common approaches to the enforcement of the European standards. The vulnerability of the European financial system is due in part to the fact that in some countries the harmonized rules have been applied less strictly, in keeping with a “light touch” supervisory model too fearful of interfering with intermediaries’ decisions. The ESAs must clearly define the procedures for applying the rulebook and verify that the national authorities ensure high quality supervision. Financial innovations and new market practices must be brought before a European forum to decide on common supervisory policies. This is the only way to prevent some countries from adopting a more accommodating stance so as to give their own intermediaries a competitive edge, at the expense of area-wide financial stability. 3.4 Collection and exchange of information The ESAs will play a major role in determining the supervisory data that are to be shared and organizing their collection and aggregation in central databases. The main users will be the national supervisory authorities, above all for evaluating the risks of cross-border groups within the colleges of supervisors. Accordingly, in this area the ESAs should involve the colleges closely, taking their cue from the structures developed in the last few years. The information centralized in databases operated by ESAs should enable supervisors to conduct effective peer group analyses. In addition to basic supervisory data, it could be most useful for supervisors to share the results of stress tests on the main banking groups and their consequent risk assessments. The best way to achieve this is to have the ESAs themselves conduct the stress tests at European level, using common scenarios and methodologies and providing for mechanisms to determine the sources of differences between single financial groups. To make this possible, access to the data must be restricted to a small group of supervisors and strict rules must be enacted to safeguard the confidentiality of such sensitive data. 3.5 Colleges of supervisors With the reform, the ESAs are given a central role in coordinating the activities of the colleges of supervisors. The first step should be setting standards for the functioning of the colleges based on today’s best practices, to enhance consistency within the Union. In this regard, the two colleges instituted by Banca d’Italia for the top two Italian banking groups represent an especially positive experience. Rules are already in course of application establishing the legal basis for the colleges, broadening their tasks – including in crisis situations – and creating joint decision-making processes for supervisory controls, which may eventually result in specific capital requirements for the groups and for their individual components. So far, the colleges have worked well where the law is sufficiently stringent in defining their tasks, as for instance in the validation of the intermediaries’ internal risk measurement models. The results have been less satisfactory where the functioning of colleges is based on voluntary commitments. To achieve a truly integrated system of controls on cross-border groups, in which the colleges can act as promptly and as effectively as national supervisors now do, it would be necessary to create the conditions for expanding the scope for concerted decision-making by the supervisory authorities. Consideration should be given to enacting Community legislation on banking groups patterned after the Italian law, which recognizes the coordinating role of the parent company and institutes a clear framework for the proper attribution of rights and responsibilities to all the components of the group. The parent company could be made responsible for interacting with the college of supervisors and making sure that the latter’s indications are complied with by all group members. 3.6 Legislation and agreements on the management of crises In line with the recommendations of the de Larosière Report, the Ecofin Council has charged the Commission to reinforce the so-called “infrastructure legislation” referring to the procedures for the prevention and resolution of crises of cross-border groups. The Economic and Financial Committee has been asked to develop proposals to improve the cooperation mechanisms for managing crises at these intermediaries. (i) The instruments for managing crises. In the first place significantly increased harmonization of legislation on the instruments for managing crises is necessary. In fact the large disparities between member states with regard to national authorities’ powers and responsibilities in early interventions and the procedures for resolving crises prevent the coordinated management of interventions involving cross-border groups. The Commission has undertaken to present proposals for European legislation in this field shortly. The procedures laid down in the Italian legislation on the management of banking crises, which include preventive measures, have proved effective and could be a useful model for guiding the work carried out at the European level. The possibility of introducing a common procedure for the management of the crises of cross-border banking groups should also be weighed. If this were not feasible, at least the application of the Directive on the winding up of credit institutions could be extended to the subsidiaries of foreign banks, as a first step towards a greater degree of harmonization in this field. (ii) The removal of obstacles to the transfer of assets within the European Union. Progress is needed in the harmonization of company and bankruptcy law to remove the obstacles that prevent the transfer of assets and liquidity between the various components of cross-border banking groups. The possibility of ring-fencing assets held in a country leads in fact to solutions that are rational from the standpoint of individual member states but inefficient in terms of enhancing the value of the group’s assets; in some cases ring-fencing may even accelerate insolvency and complicate the management of the crisis. (iii) Deposit insurance schemes. The Commission is also working to reduce the disparities still present in the working of deposit insurance schemes. The recent revision of the directive raised the levels of coverage and shortened reimbursement times, but it did not reduce the wide margins of discretion member states enjoy regarding the funding of the schemes, or the conditions for and the characteristics of the interventions. In promoting a greater degree of harmonization of these aspects, it should also be possible to consider a common deposit guarantee scheme at European level, which could interact with national deposit protection schemes and make an invaluable contribution to the coordinated intervention of national authorities in the event of crises of cross-border groups. (iv) Cooperation agreements and sharing the burden of crises. Lastly, it appears desirable to develop mechanisms for coordinated intervention in crises to minimize the impact on markets and, ultimately, on taxpayers. In line with the indications contained in the Memorandum of Understanding signed by the ministries of finance, central banks and supervisory authorities of the European Union in 2008, the Economic and Financial Committee is preparing general recommendations for agreements under which each national authority undertakes a clear commitment with regard to the support it could provide in the event of the crisis of a cross-border group. The details of these burden-sharing agreements should be left to the structures for coordination among supervisory authorities, central banks and finance ministries (crossborder stability groups) that will be set up for each banking group. Conclusions In the coming months it will be necessary to monitor the implementation of the reform closely and make sure that an ambitious and rigorous approach is adopted, as indicated by the Minister for the Economy and Finance in the note accompanying the transmission to Parliament of Consob’s Annual Report. Ambiguous solutions risk creating confusion of roles and conflicts between authorities; compromises that in reality maintain the status quo as regards national authorities’ powers or encourage lax controls do not solve the problems that the crisis has brought out. In my remarks I have tried to outline the points that can determine the success of the reform: • in the first place it is necessary to provide the European Systemic Risk Board (ESRB) with effective operational instruments and a solid institutional basis, possibly by activating Article 105(6) of the Treaty, which provides for the ECB to be entrusted with specific supervisory tasks; • then it is necessary to guarantee the independence of the new European authorities: the political authorities can be involved as observers in the process of macroprudential supervision and contribute to the implementation of the ESRB’s recommendations; the European Securities Authorities (ESAs) will have to be exclusively responsible for defining the technical standards of supervision for the European Union, with appropriate accountability mechanisms; • it is also necessary to take determined steps towards effectively uniform rules, with greater recourse to European regulations instead of directives and with the technical standards of the new authorities directly applicable throughout the entire single market without their having to be transposed. Moreover, the uniformity of the rules will have to be accompanied by equal degrees of rigour in the supervisory approaches to implementing controls and adopting corrective measures; • confidentiality mechanisms and rules will have to be introduced to ensure that confidential information is shared to a much greater extent than today, thereby facilitating the creation of common databases; • colleges of supervisors must be put in a position to function with the same efficacy in relation to cross-border groups as national supervisors; this must be ensured through new Community legislation on banking groups; • new legislation must be adopted on crisis management procedures and deposit insurance schemes, together with agreements among authorities with clear commitments on support for specific cross-border groups. I hope these suggestions may be of help to the Committee in defining its stance with regard to the proposals of the Commission and the recommendations of the Council and in providing indications to the Government on the position to take in this important institutional reorganization. | bank of italy | 2,009 | 10 |
Speech by Mr Ignazio Visco, Deputy Director General of the Bank of Italy, at The Italian Chamber of Commerce and Industry for the UK XXXI Annual Conference "A New Approach for Global Economic and Social Growth", London, 16 October 2009. | Ignazio Visco: Challenges to international cooperation in the wake of the global crisis Speech by Mr Ignazio Visco, Deputy Director General of the Bank of Italy, at The Italian Chamber of Commerce and Industry for the UK XXXI Annual Conference “A New Approach for Global Economic and Social Growth”, London, 16 October 2009. * 1. The unfolding of the crisis 1.1 Origins * * Whether the global crisis that has hit the world economy so severely since August 2007 was rooted in macroeconomic causes is an open question. To be sure, the trigger and proximate causes of the crisis were essentially financial, originating in a specific segment of the US financial system, i.e. the subprime mortgage market. Nevertheless, I believe that financial excesses could not have developed to the extent they did if the macroeconomic environment had not been characterised by large saving-investment imbalances, very low interest rates and asset price misalignments. These factors helped create the conditions in which financial innovations and regulatory failures caused serious dysfunctions in the US and global financial system. The general climate of excessive optimism that those macroeconomic conditions supported certainly contributed, with risk managers and supervisors allowing financial vulnerabilities to grow basically unchecked. Signals of macroeconomic stress, which interacted with financial system flaws to create very serious fragilities, had been manifest at least since the late 1990s. The most evident were the dramatic fall in the saving rate of American households, from around 7 per cent in the early 1990s to near zero in 2005-2007, and the persistence and significant widening of the US external deficit (from 1.6 per cent of GDP in 1997 to 6 per cent in 2006), against growing surpluses in a number of emerging economies, in particular China (from 1.3 to 11 per cent of GDP between 2002 and 2007) and the oil exporting countries. Focussing on the role of policies in sustaining this pattern of highly unbalanced growth and on how they reacted to the various shocks – geopolitical, technological and economic – to the global economy, two factors appear to have played a major role. 1 The first was the great increase in US and global liquidity, in part owing to the generally accommodating US monetary policy stance. This accompanied a protracted expansion of consumer spending financed by growing household indebtedness. At the same time, low interest rates triggered a search for yield that squeezed risk premiums on whole classes of assets and so tended to make financial conditions even more favourable for a broad range of borrowers. Abundant liquidity and credit expansion, as well as regulatory failures in some markets, helped feed an uncommonly synchronised global boom in house prices. The second element was the decision by China and other rapidly growing emerging economies to peg their currencies to the dollar as a way of supporting their essentially export-led growth model. Not only did this imply basically importing the generally easy US monetary stance; most importantly, it produced an enormous accumulation of official reserves (from $168 billion to $1.9 trillion in China between 2000 and 2008, 40 per cent of the increase in the world as a whole), perhaps as a self-insurance response in the wake of the Asian crisis of 1997-98. Largely invested in US financial and monetary instruments, these See Visco (2009b). reserves helped to finance the massive US deficit in the current account of the balance of payments and to maintain very low interest rates along the whole length of the yield curve. Both of these policies were attractive in the short term but unsustainable in the long run. In fact, when global supply encountered bottlenecks in the form of shortages of primary commodities and as inflationary pressures started to materialize, the Federal Reserve progressively tightened monetary policy, and house prices started to fall. At that point, the serious risk exposures that had been built up within the financial system suddenly became apparent, precipitating the turmoil. The relevance of this broad set of interrelated factors – macroeconomic as well as financial – in creating a crisis of these proportions is evident in the way the crisis was so rapidly propagated across financial markets and then to the real economy, not just in the industrialised world but globally. It was the unbalanced world consumption patterns that transformed what might otherwise have been a very serious but limited episode of financial turmoil into a fully-fledged global economic crisis, with plunging world trade and output. When the United States stopped serving as “consumer of last resort” the whole world suffered from insufficient aggregate demand precisely because of the unbalanced consumption patterns. 1.2 The real economic consequences The crisis has left deep scars. In the advanced economies the IMF projects the unemployment rate to reach 9.3 per cent in 2010, almost 4 percentage points above the low point registered in 2007; the shortfall in GDP, relative to potential, is projected to reach 4 per cent this year and to remain just slightly below this level in 2010. 2 But predicting the exact dimensions of this slack is complicated, since the crisis is also likely to affect potential output in various ways that are difficult to quantify. Past experience shows that the repercussions of financial crises in terms of lost output are both significant and sustained: the IMF has estimated that seven years after the start of a major crisis gross domestic product is still, on average, ten percentage points below where it would have been had it continued on the previous trend. However, growth paths after the initial output decline have differed widely in historical experiences: while in some cases output gradually returned toward the pre-crisis trend, in others the gap widened over time. It is probably still too early to tell which type of adjustment pattern will prevail this time. While there is consensus on the fact that the level of potential output in advanced countries is likely to be reduced permanently as a result of lower investment and structural unemployment, estimates of the size of this loss vary widely, around 3 to 5 per cent. What will happen to its future growth rate is even more uncertain. Both the IMF and the OECD have assumed so far that, as a first approximation, it should be unaffected. However, one could argue that we may be at the beginning of a major structural change, certainly in the financial sector and perhaps in the economy as a whole: uncertainties over the recovery of demand and the process of deleveraging in the financial sector could hamper not only investment but also the accumulation of human capital and innovation, with likely negative effects on potential output growth. 1.3 Policy responses and the outlook Policy makers’ response was generalized and remarkably well coordinated. Official interest rates were lowered rapidly; in many countries they are still near zero. Central banks injected liquidity in unprecedented quantities, extending the range of their instruments for action. The severity of the crisis has created a vast international consensus on the need to accompany monetary action with fiscal expansion. For the G-20 economies, crisis-related discretionary IMF (2009). fiscal measures are estimated at about 2 per cent of GDP in 2009 and 1.5 per cent in 2010, over the 2007 baseline. To this, we should add the substantial cost of various measures – capital injections, guarantees on bank liabilities, relief of impaired assets, liquidity and bank funding support – enacted in most countries to sustain the banking systems. This powerful response averted the danger of a systemic collapse and helped to restore market confidence and bring back a more “normal” risk appetite. The cost of money market funding has come down considerably and worry over the health of the banking system has been allayed. Corporate risk spreads have narrowed to levels close to those prevailing before the bankruptcy of Lehman Brothers in September 2008. Recently, the global economy has begun to grow again, but the recovery appears to be sluggish, uneven and highly dependent on policy support. According to the IMF central forecast, after contracting by 1 per cent in 2009 global activity should return to growth of 3 per cent in 2010 thanks to a modest upturn in the advanced economies and more vigorous expansion in the emerging and developing countries. By way of comparison, the average world economic growth rate between 2002 and 2007 was around 5 per cent. It is important to stress that there is considerable uncertainty around this scenario, and forecasters’ current views about the strength of the recovery span a wide range. For example, while private forecasters expect US GDP growth to reach around 2½-3 per cent in 2010, the IMF is projecting only 1½ per cent growth. One may wonder why we are still considering the predictions of economic forecasters after their dismal recent performance, which surprised even Her Majesty the Queen. We should not forget that forecasting activity permits the consistent organisation of our ideas and hypotheses about the most plausible path of the main economic aggregates. This is particularly useful to analysing the effects of policy actions, which usually come with timelags and through many channels. It goes without saying that economic forecasters are not fortune-tellers, and their projections always come with explicit or implicit probabilistic ranges of possible outcomes. But it is also true – to quote the great social scientist Herbert Simon – that unless the phenomena to be predicted “are sufficiently regular that they can simply be extrapolated … our predictions will generally be only as good as our theories”. 3 Some occasions are particularly marked both by the lack of sufficient regularity in the data observed and by difficulty in properly using our theories to anticipate the non-linear consequences of economic and financial decisions. This calls for special care, better discussion of alternatives and greater consideration of the possibly severe consequences of what may be seen, ex ante, as rare events. But modesty in our evaluation of economic projections should only be seen as a call for more transparency and better analysis, not as a refusal to use quantitative assessments based on an informed and probabilistic reading of the available evidence. Anyway, the general view of the latest official projections is very cautious and correctly postulates that the support deriving from the fiscal stimulus and inventory rebuilding cannot last forever. Beyond the short term, it still remains to be seen how soon and how far private demand – consumption and investment – can take up the slack and give rise to a selfsustaining recovery. In fact, in much of the industrial world private consumption is still stagnating at best, and its weakness appears even more significant if one excludes the effects of temporary measures, such as the various “cash for clunkers” schemes in the United States and in the major continental European countries, or the reduction of the VAT in the United Kingdom. To the extent that subsidies have merely brought part of households’ planned expenditure forward, once these programmes expire consumption may lapse again. With anaemic demand prospects and with banks still curbing credit as they deleverage, investment too is bound to Simon (1972), p. 170. See also Visco (2009a). be sluggish at best for some time. And without a pick-up in the pace of investment it is hard to imagine any return to a healthy growth path. The main risk is that rising unemployment rates will undermine household confidence and depress spending. As long as jobs are still being lost, there is plenty of potential for destabilizing feedbacks. Lower employment can trigger more mortgage defaults and put additional stress on key financial institutions. In other words, as long as the employment picture continues to worsen, the risk that things could deteriorate again remains great. 2. Challenges for international cooperation 2.1 Repairing the financial system One of the main challenges is to complete the repair of the financial system so that it can support the return to sustained and stable growth. As the financial markets appear to be regaining confidence, it is important that the reform momentum not be lost. The decisions of the G-20 summit in Pittsburgh point to a renewed effort to overcome the deep flaws that affected the financial environment prior to the eruption of the crisis. Although the question of capital requirements for banks is certainly most prominent, it should be considered only part of the solution. To discourage excessive leverage, the quantity and quality of bank capital should be raised. But it is also of paramount importance that the perimeter of regulation be extended to cover all systemically important institutions. Regulatory systems must be harmonised to limit the potentially disruptive repercussions of regulatory arbitrage. In this context, the prudential framework should be designed to prevent the pro-cyclical accumulation of financial vulnerabilities during booms and sharp deleveraging during crises. There is also widespread recognition of the need to reform corporate governance in the financial sector, so as to align executive compensation with long-term performance and ensure greater transparency. All these measures should help deal with the threat posed by institutions “too big or too interconnected to fail”. Better mechanisms should be devised to limit the costs of failure, but widely shared solutions are still to be found. Resolution plans and a stronger capitalisation may mitigate but will not eliminate the financial fallout of the bankruptcy of one of these institutions and the related moral hazard. 2.2 Rebalancing the sources of global growth Whatever shape the future financial system may take, it is urgent to rebalance the sources of global growth. At present, the main priority of monetary and fiscal policies in all the advanced and in many emerging countries is still to support economic recovery by compensating for the weakness of private demand and countering the effects of financial deleveraging. As a result of the crisis and the strong policy response, the public finances have deteriorated notably. Under current policies, budget deficits in the advanced countries are projected to remain very large and gross public debt may rise over the next five years above 110 per cent of GDP, from 80 per cent before the crisis. If maintained for too long, the substantial fiscal and monetary stimulus enacted during the past year could become a new source of instability. So the most challenging task for economic policy is timing what are now called “exit strategies”, i.e., when and how to phase out these exceptional measures. This involves striking a delicate balance. As the recovery of final demand is likely to be lacklustre for some time, support should not be withdrawn prematurely. At the same time, credible exit strategies are crucial to reassure the markets as to the commitment to price stability and a return to sound and sustainable public finances. Central banks have already made it clear that they have the tools necessary to withdraw excess liquidity, and are determined to do so as soon as conditions warrant. The most delicate challenge is to choose the appropriate timing and speed for exiting from “unconventional” measures and for raising interest rates. In this process, the strength and durability of the recovery will have to be taken into account, as well as the progress toward financial system repair. In designing the appropriate fiscal policy response, it is important to take expectations into account. The economic slowdown partly reflects the pessimistic expectations of economic agents. A well-designed and well-targeted fiscal plan can help the recovery by boosting the confidence of households and businesses. Also the financial markets’ reaction to any given level of public debt is powerfully influenced by their expectations on future fiscal behaviour. Accompanying the fiscal stimulus with credible action to right the public finances in the medium term can limit the rise in interest rates stemming from a temporary upsurge in debt. This strategy is particularly important for countries with high debt or a weak reputation for fiscal rectitude. The problem, particularly at the present juncture, is how to make this commitment to medium-term consolidation credible while preserving the necessary flexibility in the short term. On the one hand, the commitment to a long-term objective may not be credible without an indication of how to get there. On the other hand, because the shape and strength of the economic recovery are so uncertain right now, and because the premature end to fiscal stimulus could easily derail it, governments may find it difficult to stick to pre-announced fiscal targets. Going forward, the need to move towards more sustainable fiscal positions will require tough policy choices in a number of countries. Although the challenges posed by the projected rise in health and pension costs connected to population ageing have been well known for some time, with substantial comparative assessments produced by the European Commission, the IMF and the OECD, 4 the fiscal costs of the crisis have now sharply reduced the margins for manoeuvre, and addressing those challenges can no longer be postponed. Governments need to commit credibly, now, to curb the future growth of those entitlement programs; this could provide space for a more gradual removal of fiscal support. However, the manner in which the eventual consolidation is carried out will also be important. If the mix of expenditure cuts and (probably unavoidable) tax increases could be engineered so as to minimize the adverse impact on medium-term growth, the consolidation would be less painful. For instance, as much as possible the penalization of growth-enhancing expenditures, such as R&D investment, education and overall human capital formation, should be avoided. Over the medium term, the crucial factor for sustained growth is a better balance in global demand. The rise in US private-sector saving and the sharp fall in investment, partly offset by a larger public sector deficit, appear to have cut the US current account deficit from 5.3 per cent of GDP in 2007 to 2.6 per cent in 2009, as projected by the IMF. The Chinese surplus has also been reduced, from 11 to about 8 per cent. However, most of these corrections are due to cyclical, not structural, factors. If the recovery is driven by demand in the surplus countries – not only emerging Asia, but also Japan and some European countries – then some real correction of imbalances is possible. A major rebalancing of world demand from deficit to surplus countries presupposes coherent movements in exchange rates. I do not intend to pinpoint exactly where exchange rates should be. After all, no one knows what is the correct or “fair” value of a currency. But the risk of a disorderly adjustment in exchange rates has to be averted. I think the solution is See, for the most recent assessment, the report by the European Commission (2009), where on the basis of current policies, the age-related public expenditures (especially for pensions, health and long-term care) to GDP ratio is still projected to increase in the European Union, on average, by about 3 percentage points by 2035 and 5 percentage points by 2060. unlikely to consist either in asking countries with dollar-peg regimes to shift abruptly to a fully flexible regime or in the quest for the “holy grail” of a single world currency – which would require very high flexibility in the markets for goods and services in all the national economies. As the rebalancing of world demand proceeds, reasonable solutions based on intermediate regimes, such as target zones or bands and currency baskets, should not be dismissed out of hand. There is now a growing awareness of the importance of rebalancing, as the Pittsburgh summit acknowledged. However, it is still not evident how (and whether) any given country will in fact implement such shared understanding. If the current situation does not change, shifts in saving and investment will not be able to correct global imbalances, thus feeding the expectation of significant exchange rate adjustments and triggering potentially disorderly movements. 2.3 The increasing role of international cooperation In the last few months several fundamental changes in the IMF’s modus operandi have been agreed, as well as an increase in its financial size. First, the Fund’s lending framework has been reformed radically. In particular: (a) conditionality has been simplified and tailored to the varying strengths of countries’ policies and fundamentals; the IMF will rely more on pre-set qualification criteria (ex-ante conditionality) and less on traditional (ex post) conditionality as the basis for access to its resources; (b) a new Flexible Credit Line (FCL) has been introduced, for countries with very strong fundamentals, policies, and track records of policy implementation. Countries eligible to the FCL are granted large and upfront access to Fund resources, within limits to be assessed on a case-by-case basis and with no ongoing (ex post) conditions; (c) the traditional stand-by lending arrangements have been made more flexible, to enable high access on a precautionary basis for members that do not qualify for the FCL; (d) non-concessional loan access limits for countries have been doubled (to 200 and 600 per cent of quota on an annual and cumulative basis, respectively), in order to bolster countries’ confidence that adequate resources would be available to meet their financing needs. Second, and perhaps more important, the Fund’s lending capacity has been trebled from the pre-crisis level, from $250 billion to $750 billion. A number of advanced and emerging countries have volunteered to lend new resources for more than $500 billion, through bilateral loans and IMF notes purchase agreements. On the whole, the IMF’s lending toolkit has been re-oriented from crisis resolution to crisis prevention, and the substantial increase in financial capacity has enhanced its credibility as a multilateral insurance mechanism. The FCL plays a special role in this new framework. Its success so far (as in the cases of Mexico, Poland and Colombia) bears witness of a radical shift in the sentiment of the potential beneficiaries. Third, a decision has been taken to allocate new Special Drawing Rights (SDRs) equivalent to $250 billion, two fifths of which to emerging and developing countries. SDRs are a means for IMF members to obtain freely usable currencies from other members, and they therefore help to increase countries’ international reserves. One purpose of these reforms is to convince emerging countries to abandon the quest for self-insurance through the massive accumulation of official reserves against potential crises and go over instead to a mutually accepted system of multilateral insurance provided by international financial institutions. In recent years, many emerging market economies have relied upon reserves for their precautionary needs. Some countries, especially those running persistently large current account surpluses, have accumulated reserves far above any reasonable benchmark. However, large reserve holdings can generate costs both for individual countries and for the world economy as a whole. For an individual country, the issuance of domestic debt aimed at absorbing excess liquidity from abroad carries a fiscal cost if the domestic interest rate is higher than the return on official reserve assets; furthermore, and perhaps more importantly, the country risks large capital losses if, sooner or later, its currency is revalued. More generally, large reserve holdings entail a misallocation of resources that could have been more efficiently invested domestically. From a global standpoint, the accumulation of reserves in some countries has been the counterpart of the external deficits run by others, which have been a key co-driver of the crisis, the global recession, and the collapse of world trade. Does this imply that the IMF can act as international lender of last resort and provide full coverage of the potential needs of its members? I do not believe that time is ripe for such a bold move. While the IMF is now well-equipped to mitigate the economic disruption from sudden stops in capital flows and from the perceived need for excessive (and expensive) official reserves, I am convinced that sound macro-financial policies at the country level remain essential to strong, sustainable and balanced global growth. In an interdependent world these policies should take into account, as much as possible, the spillovers to the global economy. Here is where the IMF’s surveillance function can play a decisive role. In the recent past the Fund has failed to get major countries to steer their domestic policies towards reducing their large external imbalances. To be sure, this was an extremely difficult task, since the logic of surveillance rests on the postulate that policy makers should cede a measure of sovereignty in the interest of international cooperation. Unfortunately, this happened only in a very small part. Going forward, the global crisis might have had the beneficial effect of forcing policy makers to think outside the box, i.e. to act cooperatively to rebalance world demand and steer the global financial system. This is a very big challenge, and one should not cultivate exaggerated expectations. However, we should acknowledge that, in this respect, in less than a year the G-20 and the Financial Stability Board have become the new protagonists: the first, as a sort of world economic “steering committee”, which availing itself of the IMF’s analysis and advice can enhance international cooperation on all fronts and help achieve balanced and sustainable growth; the second – enlarged and institutionalized from its predecessor, the Financial Stability Forum – to make substantive progress in the key task of setting out financial and regulatory standards that will also involve the Basel committees, as well as the Fund. 3. Structural reforms to sustain growth 3.1 Structural reforms in times of crisis Rebalancing cannot be achieved without sound structural economic policies. The joint statement released at the G-20 summit in Pittsburgh acknowledges that a strong recovery will necessitate “macroeconomic policies that promote adequate and balanced global demand as well as decisive progress on structural reforms that foster private domestic demand, narrow the global development gap, and strengthen long-run growth potential.” In the aftermath of the economic crisis, pro-growth structural reforms may be held back. As the main focus of policy-making during the recession has been demand support, the issue of structural reform may well be downplayed or even set aside. In part this may reflect political reasons: insofar as reforms have short-term costs, the political appetite for them could be low. But this would be a lost opportunity. The reform action must not be halted by more urgent needs linked to the current crisis. It must continue to remove the obstacles to growth that lie in low levels of competition and several rigidities in product and labour markets. A constant monitoring of the progress in each country should provide an important stimulus for action. This is the aim of the OECD program Going for Growth, launched in 2005, which provides a sort of structural surveillance on OECD member countries. A possible extension outside the OECD membership could be a significant step forward. The nature of the present crisis demands a general review of financial regulation around the world. Specifically, there is a need to broaden the perimeter of regulation and to adopt new rules. After the years in which markets were presumed to be self-regulating and public rules were abolished or greatly relaxed, the financial landscape will now have to be reshaped with more pervasive regulation, both domestically and internationally. This is a necessary step toward ensuring a functioning financial system and fostering the return of confidence to the credit markets. There is a risk, understandable, that for some time regulation of financial markets might turn out, ex post, to be even too heavy. We should be careful not to extend this pro-regulation attitude to other product and service markets where some regulatory easing is needed. Were not this the case, the outcome would be to weaken competition and increase monopolistic rents, favoured by administrative burdens and inefficiencies. Innovation and the evolution of productivity would be impaired in the long run, with negative consequences for economic growth. However, policy action must be carefully designed to avoid flawed structural interventions or measures that could jeopardise the benefits of recent reforms. The early retirement schemes introduced in many European countries were intended to foster youth employment, but after a good many years most of them proved to be failures. Similarly, incentive schemes targeted to specific sectors risk creating a dangerous dependence on public support and should accordingly be phased out quickly. 3.2 Support to domestic demand in emerging economies In most economies with external surpluses, it is crucial to establish the conditions for expanding private consumption and investment. Take China, for instance. In 2008 the Chinese current account surplus of 10 per cent of GDP was equivalent to about a third of the total surplus of Asia (including Japan) and the major oil exporting countries. Gross domestic saving amounted to 50 per cent of GDP. Such high saving (half of it generated by the business sector) together with very low household consumption (35 per cent of GDP, half the ratio for the United States) are striking by international standards. Underlying these figures are very substantial reinvested earnings and the high household propensity to save (on average 25 per cent of disposable income), mainly out of precautionary motives. Lack of basic social services – health care, education and pension benefits – for a rapidly ageing population, together with credit constraints, has greatly increased the need for selfinsurance. At the same time, an output structure intensely skewed towards capital-intensive industries, the underdeveloped state of financial markets and privileged access to bank lending by large state-owned enterprises are all factors inducing firms to finance investment largely out of retained earnings. In this context, demand-side reforms are needed to reduce precautionary saving, while supply-side measures should aim at shifting output composition more towards labour-intensive activities, chiefly in the service sectors. As for social services, the recent health care reform is a step in the right direction, although the share of the anti-crisis stimulus package allocated to overall social welfare programs is small indeed compared to that going to infrastructure and other public investments (0.5 and 11 per cent of GDP respectively). The service sector would benefit greatly from financial system reforms to stimulate credit to small and medium-sized enterprises, which until now have been severely constrained. This could prompt the emergence of a large middle class and lead to a better distribution of income, thereby increasing the overall propensity to consume. 3.3 Reforms to boost growth in the advanced economies The Chinese case, and that of the emerging countries in Asia generally, differs from other countries running an external surplus or a small deficit. For Japan and some European countries, such as Germany and Italy, where the scope for fiscal manoeuvre is limited, structural reforms should be directed at the sectors where heavy regulation limits competition, hindering innovation and productivity growth. The deregulation of the telecommunications market in the 1980s and 1990s helped to spark the formation of new companies and the introduction of new products, thereby raising demand. Something similar could be done for professional services and retail trade, which are still characterised by relatively pervasive regulation. These are reforms that would not be difficult to implement and would entail potentially very large gains in potential output. We are probably going to experience what many commentators are already calling a “jobless recovery”. In fact, unemployment is rising all over the advanced world: in the United States the rate is expected to hit double digits within the next few months and to stay there throughout much of 2010. The fiscal and monetary stimulus have saved a lot of jobs, but it is widely recognized that extra effort is needed to help employment to recover quickly. What is particularly disturbing in the current juncture is that jobless workers tend to remain unemployed for longer than in the past, to the detriment of their human capital. This tendency must be countered by a proper reform effort: the evolution of potential output depends on the level of a society’s human capital. As the G-20 said, “Each of our countries will need, through its own national policies, to strengthen the ability of our workers to adapt to changing market demands and to benefit from innovation and investment in new technologies, clean energy, environment, health, and infrastructures”. Active labour market policies may help workers acquire the skills that will be needed as the economy revives. This has implications not only in the short term – enabling people to find jobs and so increasing their spending power – but in the long term as well – by raising productivity. Both in Britain and Italy there is a growing awareness of the need to improve our education system in order to seize the opportunities offered by innovation and technological progress. This can be achieved by raising the population’s level of training and education (in Italy it is the lowest among the advanced economies), so as to boost productivity and assist low-skilled people. Better educational attainment and wider distribution of educational resources should help close socio-economic gaps and promote social mobility, as is described in considerable detail in the British government’s “New Opportunities” White Paper. 5 The severity of the crisis, its pervasiveness across countries and economic sectors, has led a good many commentators and policy makers to question the validity (and predictive capability) of economics as a science. I beg to differ, although of course I do not deny that our knowledge, understanding and predictive ability can be substantially improved. I agree that rapid innovation and globalization, particularly evident in the financial markets, have produced an environment whose implications have not been adequately appreciated. But it should be recognized that the warning signs of the building-up of very serious macroeconomic imbalances were pointed out repeatedly – to be sure, with some dissenting views as to their unsustainability. What has been lacking, along with an adequate response of regulators to the build-up of financial risk, has been the recognition of the need to reduce the misalignments in real and financial asset prices and to cooperate and act collectively to counter the global imbalances. Further, as suggested above, I still believe that much can be done to improve the working of our economies at the structural level. I think that the analysis and the empirical evidence on the sources of economic growth still support what I wrote introducing, soon after the bursting of the dot-com bubble and in a different capacity than the one I now have, a detailed HM Government (2009). summary of research conducted at the OECD. Namely, “contrary to simplistic beliefs, regulatory reforms are not the same as unconstrained deregulation, enhanced competition does not mean uncontrolled laisser-faire, and the reduction of excessive employment protection does not inevitably imply widespread job insecurity. The quest for most appropriate conditions to foster investment opportunities and economic growth needs to focus on enhancing market efficiency and innovation, promoting the accumulation of knowledge and increasing the diffusion of new technologies”. 6 4. Conclusion The challenges for the international community are formidable, the recovery is still in its infancy, halting. But we must not miss the opportunity to start reforming our economies to make the productive system more efficient and more resilient to shocks. The G-20 summits here in London last spring and more recently in Pittsburgh have displayed remarkable consensus on analysis and remedies. All the countries agreed to adopt a Framework for Strong, Sustainable and Balanced Growth, underlying the need for more systematic international cooperation. Many reform measures have already been taken and others should follow soon. The response of markets and analysts has been generally positive, although a number have questioned the real willingness to apply the reforms. Some recall Much Ado About Nothing; others, worse still, cite what Tomasi di Lampedusa has the Prince of Salina say in The Leopard at the time of Garibaldi’s conquest of Sicily: “Change everything so that nothing changes”. Now more than ever, we must reject any such stance and work to strengthen the current recovery and safeguard the future health of our economies. To this end, we need to encourage a pro-reform attitude – in the international monetary system as well as in the advanced and emerging economies – and to make sure it is translated into concrete actions, to maintain the momentum in our collective and cooperative efforts. References European Commission (2009), “The 2009 Ageing Report: Economic and Budgetary projections for the EU-27 Member States (2008-2060)”, European Economy, 2. HM Government (2009) “New Opportunities – Fair Chances for the Future”, presented to Parliament by the Minister for the Cabinet Office, London, January. IMF (2009), World Economic Outlook, October. OECD (2003), The Sources of Economic Growth in the OECD Countries, OECD, Paris. Simon, H. (1981), The Sciences of the Artificial, MIT Press, Cambridge, Mass. Visco, I. (2009a), “The Financial Crisis and Economists’ Forecasts”, BIS Review, 49, available at http://www.bis.org/review/r090423f.pdf. Visco, I. (2009b), “The Global Crisis: the Role of Policies and the International Monetary System”, BIS Review, 87, available at http://www.bis.org/review/r090715e.pdf. OECD (2003). | bank of italy | 2,009 | 10 |
Address by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, on the occasion of the 2009 World Savings Day, at the Association of Italian Savings Banks (ACRI), Rome, 29 October 2009. | Mario Draghi: 2009 World Savings Day Address by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, on the occasion of the 2009 World Savings Day, at the Association of Italian Savings Banks (ACRI), Rome, 29 October 2009. * 1. * * The new regulation of finance Conditions in the financial markets have been improving steadily since last spring. Banks are again raising funds in the private bond and share markets. The risk premium indicators are coming down. However, neither risk premiums nor funding costs have come back to their 2007 level, and there is no reason to think this will happen any time soon: the market has not forgotten that the crisis was the consequence of its own recklessness. Nor is it desirable that it should happen. The magnitude of the economic policy response to the crisis testifies to the severity of the trauma. Things will not be the same as before, and all financial market participants, starting with the banks, would do well to recognize this. The Financial Stability Board is proceeding with the design of new regulatory arrangements that can give us a financial system with more capital, less debt, controls covering all intermediaries that may potentially generate systemic risk, mechanisms to limit the cyclicality of the financial system, and methods of governance and executive compensation designed to reduce the incentive for excessive risk-taking. In a word, a more prudent and more stable financial system better able to sustain the economy. We need to introduce new rules to improve the quality of capital and to curb the excesses of leverage, including the imposition of a leverage ratio. There will be major corrective measures to mitigate the procyclical tendencies of the system. Banks will be required to build up a capital buffer during the expansionary phases of the cycle to draw on at times of generalized difficulty. It has already been proposed to mandate a significant increase in the capital charges on trading activities and exposures to securitization instruments. The Basel Committee has begun work on the comprehensive revision of the notion of regulatory capital. For now, the orientation is towards a restrictive definition of core tier 1 capital, which for public limited companies should be limited essentially to common equity and reserves. All deductions, under this approach, would be harmonized according to extremely rigorous criteria and applied exclusively to the highest-quality capital component. Limited derogations to take account of the specific characteristics of cooperative societies are under discussion. By the end of the year the Committee will present new provisions on liquidity management and supervision, so that banks can deal with unexpected market stress better than in the past and manage maturity transformation more carefully. This set of rules will be subject to a detailed impact study in the course of 2010. The rules will be phased in gradually enough not to impede the economic recovery. In the first few months of 2009 the United States conducted a stress test to gauge the ability of American banks to withstand adverse macroeconomic conditions. Thanks to the publication of the results, which reassured the markets, the US banks involved in the exercise have been able to raise some $150 billion on the market since the beginning of the year. Some of them have repaid the funds obtained from the government in advance. In Europe, the Committee of Banking Supervisors (CEBS), in cooperation with national supervisory authorities, the ECB and the Commission, recently concluded a stress test of its own on the 22 leading European banking groups. Even under the worst-case macroeconomic scenario, all the groups were found to have an adequate capital endowment (a tier 1 ratio of more than 6 per cent, compared with a regulatory minimum of 4 per cent). Some European banks too have carried out capital increases. Some have repaid, or forgone, the public funds made available to them for recapitalization. Lowering the probability and lessening the impact of the possible failure of systemically relevant financial institutions and strengthening the financial system’s ability to absorb such shocks are now key objectives of regulators worldwide. Once the institutions have been identified, selective measures will have to be drafted to increase their soundness, to limit if necessary their size and range of business, to strengthen the authorities’ crisis-management capabilities and to reinforce the infrastructure of the markets. Action is also being stepped up to shift derivatives trading onto central platforms or regulated exchanges. Proposals to this effect will be presented to the G20 within the next few months. The new rules on executive compensation presented by the FSB at the latest G20 summit apply to top management and to anyone who has the power to make decisions with a significant impact on the balance sheet of a bank. They provide that a good part of compensation should be variable, dependent on the bank’s performance, but with payment deferred for at least three years and in the form of securities, and with a claw-back clause in the event of unsatisfactory performance by the bank or the executive. The aim of these rules is to counter excessive risk-taking, the pursuit of short-term gain and opacity in compensation. They emphasize disclosure and the control function of the board of directors and the shareholders. Above all, they extend regulatory jurisdiction to the sphere of executive compensation. A first check on their application is scheduled for March 2010. In March 2008 the Bank of Italy introduced principles and implementation guidelines on this matter that apply to all banks, thus in part anticipating international developments. Yesterday additional criteria for application were notified to all intermediaries. The most important banking groups have been asked to adapt promptly to the latest standards issued by the FSB and to plan any corrective measures by the end of the year. We are now in a decisive phase. The determination shown by international cooperative efforts in conceiving and drafting new rules for the international financial system must be harmonized at international level and implemented rigorously at national level. Protectionism – above all financial protectionism – is no way out of the crisis. 2. The Italian banks The Italian banking system has weathered the crisis better than many others, but we must not lower our guard because fragility still remains. Italian banks’ capital is above the minimum regulatory requirements. Data for June show that the five largest groups had improved their capital positions compared with the end of 2008. Their total capital ratio, the ratio of total capital to risk-weighted assets, rose by 0.6 percentage points to 11 per cent; their tier 1 ratio rose by 0.7 points to 7.4 per cent. Their core tier 1 ratio – excluding hybrid capital instruments and considering only the highest quality components of capital – rose by 0.8 points to 6.6 per cent. Their financial leverage remained low by international standards. The rigour the Bank of Italy has applied in its prudential supervision of banks’ capital has protected them in this critical phase. A more general revision of the entire supervisory process has been under way for some time: stress tests are an instrument that we now use continuously; specialist inspection teams are constantly present at the largest and most complex banking groups, to analyze specific questions and risk profiles. We must not overlook the dangers inherent in a still delicate economic situation. Credit quality is deteriorating rapidly. In the second quarter of this year the seasonally adjusted ratio of new bad debts to total loans rose to just under 2 per cent, from 1.6 per cent in the first quarter. The increase was especially large for loans to firms (from 2.1 to 2.6 per cent). The effects of the recession on banks’ profits are already significant. For the five largest groups, although their operating income held up well, their first-half profits fell by nearly 60 per cent compared with the first half of 2008 owing to the increase in provisions against credit risk. Since the beginning of 2009, financial analysts have repeatedly revised their profit forecasts downwards. Earnings are expected to recover only in 2011, and even then they will remain below the results achieved in 2008. It is essential that banks allocate a significant volume of resources to strengthening their capital bases. They must use all the instruments available to increase their capital. They have already begun to do so, with public recapitalizations, the recourse to the private capital market, and asset sales. Italian tax rules set strict limits on the deductibility of loan writedowns from taxable income, stricter than those in force in other major European countries. This leads to substantial deferred tax assets that, looking ahead, new regulations will not allow to be included in banks’ regulatory capital. We hope that the willingness of the Government to re-examine these aspects of the tax rules, in relation to the performance of the moratorium on bank debt, will be translated into concrete measures that will remove this obstacle to the expansion of credit. The changes on the horizon of the international regulatory and market landscape closely concern Italian banks. Under the new arrangements that will prevail at global level, much more capital will be needed than in the past. It will have to be attracted and remunerated in an earnings setting that will be constrained by greater competition. This strategic challenge can only be won by banks able to improve the quality of their services and increase their efficiency. Italian banks have already demonstrated in years past that they can increase productivity. Comparisons made by the Bank of Italy and the Bundesbank show how technological progress and the achievement of economies of scale through concentrations fostered an increase in banking sector productivity in both countries in the decade that began in the mid1990s. But productivity in Italy, initially lower, grew at a higher average annual rate (about 3 per cent) than in Germany, benefiting among other things from the privatization process under way in that period. Italian banks must also win another strategic challenge. They came out of the crisis fundamentally unharmed; they must turn this favourable position into an edge over their competitors and a benefit for their customers. 3. Transparency and the protection of savings The Bank of Italy is responsible for overseeing the transparency of banking products. This responsibility is entrusted to the Bank by law, it is part of the protection that lawmakers have established for savings: entered into the credit circuit, these savings are the fundamental ingredient in the financing of growth. Without customer confidence, based on adequate transparency, this mechanism does not work, growth languishes. a. The cost of current accounts The surveys made by the Bank of Italy show that the average cost of bank current accounts has been basically stable. The cost varies considerably around the average, equal in 2008 to €114. Other things being equal, accounts opened more than two years ago cost more than those opened more recently. There is room to improve the conditions to which customers are subject. b. The cost of credit facilities and overdrafts The recent legislative measures on the costs of credit facilities and overdrafts have produced some of the desired effects: banks have changed the structure of fees, also with a view to recouping the lost income from items that have been banned by law. The initial results of a survey we recently conducted indicate that the fees introduced this year following the legislative measures are generally less costly than before for customers; nevertheless, in about a quarter of the cases examined, the new fees are higher than those in place at the end of 2008. Banks must rapidly, drastically and definitively simplify the structure of commitment fees. Since August the new instructions for calculating the average percentage rates for the purpose of preventing usury envisage the inclusion of all the charges borne by the customer for the disbursement of credit, including costs that had previously been excluded, such as the maximum overdraft fee, where it is still applied, commitment fees and some insurance and broking charges. For some categories of transaction, the explicit inclusion of these new items has a significant impact, producing threshold rates that are higher than in the past and more representative of the economic terms and conditions applied to customers. This will make it possible to counter circumvention of the usury thresholds and also to curb the amount of ancillary costs. c. New rules on transparency and correct conduct In July we issued new rules on the transparency of banking services and correct conduct in relations with customers. The use of composite indicators for current accounts will allow customers to compare the costs of the different offers available on the market; the year-end account statements will contain a specific invitation to customers to verify the advantageousness of their existing accounts via the Internet or at their bank. The cost of credit facilities will be made more comprehensible, among other things by enabling customers to calculate and compare in advance the potential cost of the overdraft. It is not easy to combine simplicity and completeness of information to customers when the products offered are diversified and complex. The new rules pay special attention to the less sophisticated customers: standardized documents that can be read at different levels; costs of services clearly indicated; a “simple current account” for the basic banking customer, with a fixed yearly account fee; an all-inclusive year-end account statement; practical guides showing consumers how to choose the current account or mortgage that best suits their needs. d. The Arbitro Bancario Finanziario The Arbitro Bancario Finanziario (ABF) became operational on 15 October when the Bank of Italy appointed the members of the three panels established in Milan, Rome and Naples. This new disputes review body can help to improve the substantive balance between the contracting parties and raise the level of satisfaction of banking and financial service users. The ABF will examine the merits of the intermediary-customer relationship; orient the conduct of intermediaries towards higher standards of correctness and transparency; and, by well-organized, efficient handling of complaints that is attentive to the customer’s reasons, give intermediaries an incentive to pursue preventive settlement of disputes. Appeals to the ABF can be presented at all the branches of the Bank of Italy; special operating units perform the function of technical secretariat for the panels, evaluating whether the documentation submitted by the parties is complete and proper, and carrying out the inquiry. An information campaign on the ABF is now under way with a dedicated website and widespread distribution of informational material for customers. In this way, we are completing our array of initiatives for the effective improvement in relationships between intermediaries and customers. The Community Legislation Implementation Law for 2008 delegates powers to the Government for the comprehensive reordering of the legislation on relations between banks and customers. The numerous legislative measures of the past years can be set in a systematic framework that clearly affirms the principles of consumer protection, fills in normative gaps, avoids unjustifiable disparities in the treatment of similar matters, and strengthens the sanction apparatus. As I recalled in my earlier testimony before the parliamentary committee of inquiry into the mafia and other criminal organizations, during periods of crisis – when firms and the financial system are most vulnerable to criminal infiltration – action against money-laundering must be even more vigilant and vigorous. Strict compliance with the anti-money-laundering rules is not only a legal obligation; it is also vital to banks’ reputation. The Financial Intelligence Unit and the Bank’s Supervision Departments have stepped up their controls, including at bank-branch level: the complementary relationship between prudential supervision and the fight against moneylaundering is being implemented within the Bank’s own organization. Collaboration with the judiciary and the finance police continues to be efficacious. But only if top management itself fully takes up the aim of combating crime can banks establish the organizational arrangements that provide the chief defence against moneylaundering. In connection with the so-called fiscal shield for the disclosure of foreign assets, an interpretative measure is called for to clear up all uncertainty over intermediaries’ obligation to report suspicious transactions and reaffirm the regular application of the anti-moneylaundering legislation. 4. The role of the banking foundations The foundations have been an anchor for Italian banks. They have accompanied them through the worst storms of the financial crisis, strengthening their capital and reserves; they are supporting them now in the weak recovery that is projected. Many have accepted sacrifices in the short term, thus contributing to the soundness of the system, the ability of banks to supply credit to the economy, and the enhancement of their own investment in the long term. The crisis has shown how the foundations can go beyond the function expected of institutional investors, which have an authoritative voice while clients are entrusting them with savings to manage, but their voice fades and dies away when savings are withdrawn. The foundations’ voice does not follow the ups and downs of the markets, and their gaze tends to focus on the medium-long term. The crisis has clearly demonstrated the limits of the short-term view, dominated by the rush towards higher and higher returns and exorbitant management fees, which in general have now fallen. Following the important mergers of two years ago, the Italian banking system needs stability to meet the management and strategic challenges that exiting the crisis will pose. It needs the Foundations to continue to accompany the strengthening of capital and reserves and to persevere in the role of shareholders who are present but do not interfere with management, which has been the basis of their success in recent years. The Bank of Italy hopes that the Foundations will continue to demonstrate the same farsightedness that kept them tied to their traditional strategic values at the height of the crisis, and that they will be able to take the long view and contribute to the development of a sound banking system ready to face the challenges of international competition. 5. Overcoming the recession and returning to growth Thanks to the powerful support provided by economic policies, the world economy has resumed growing, albeit at modest rates that vary regionally. According to the latest IMF forecasts, world output, after falling by more than 1 per cent this year, should increase by around 3 per cent in 2010; the expansion will be fairly moderate in the advanced economies, robust in the emerging and developing countries. The downward spiral of our economies in late 2008 and the early part of this year has halted. We are less certain that a truly lasting recovery is under way, one that rests on more than the extraordinary support of economic policies. In Italy, industrial production has contracted by a quarter since March 2008 and GDP by 6.5 per cent; we are back to the level of twenty years ago in the first case, almost ten years in the second. But the most acute phase of the crisis is now past: GDP resumed growth in the third quarter after falling constantly for over a year. Although, opinion polls have suggested a more favourable outlook since the spring, the signals coming from the quantitative indicators, particularly domestic demand components, remain weak. Household consumption decreased by 2 per cent in the year to September, owing to the contraction in real disposable income and the deterioration in labour market conditions. Over the same period employment fell by 3.3 per cent (650,000 jobs), while the ratio of hours of Wage Supplementation to total hours worked rose from 1.5 to 10 per cent of total hours worked. Presumably, more jobs will be lost in the closing months of this year. Investment fell by 15 per cent in the same period. Firms’ opinions regarding the conditions for investing, although less pessimistic in our September survey than a few months earlier, do not indicate a strong upturn. None of the contractions in output recorded during the various recessions that Italy has experienced since World War II was as large as on the present occasion, and yet it never took less than two years re-gain the pre-recession levels. This time, the recovery could take even longer. Economic history teaches that recessions caused by financial crises are longer lasting. Today, we in Italy have the advantage of a lower level of private debt than other economies and a banking system that has not been damaged directly by the crisis. However, we do need to tackle the structural weaknesses of our economy in order to build a lasting recovery that is not founded on exports alone. A year ago, on this same occasion, I stressed that the sudden worsening of the crisis necessitated to introduce measures to support demand and the income of the worst-hit social groups, but always with an eye to the constraints imposed by our large public debt. Now, the most urgent need is to resume the path of reform to bring the country back, in the years to come, to a high rate of economic growth, which is also the best guarantee of financial stability. 6. Financing the Italian economy There is no sign of a turning point in lending, as yet. In Italy, lending to business decreased by 3 per cent on an annual basis in the third quarter of this year; lending to households continued to expand, but slowly. The deceleration was particularly sharp in the case of the leading banking groups, the main users of the international wholesale liquidity markets. The refinancing difficulties experienced by the banks have been attenuated, partly thanks to government support and Eurosystem operations, and their liquidity situation is returning to normal, according to the latest results of the weekly monitoring exercise instituted by the Bank of Italy in the autumn of 2007. A difficult economic situation reduces the demand for credit, while its supply also becomes tighter. This phenomenon was very evident during the worst of the crisis, but now shows signs of easing similar to those found for the euro area as a whole in the ECB’s latest Bank Lending Survey. The reduction of Eurosystem interest rates led, in Italy, to a generalized lowering of the rates applied to households and firms, similar in scale and pace to the rest of the area. In September, the average cost of short-term loans to business was 4 per cent, almost 3 points lower than a year before; variable-rate mortgages for households was cut by more than half, to 2.3 per cent. The average cost of fixed-rate mortgages fell by one point, to 4.9 per cent. In some sectors, however, notably consumer credit, the cost of borrowing in Italy continues to be higher than in the rest of the euro area. In exceptional situations such as the present, variations in creditworthiness are considerable, especially among firms. The banks’ ability to make the right selection of borrowers becomes crucially important. The crisis overtook our productive system at a time when certain sectors were undergoing a laborious reorganization, begun in the middle of this decade. This process must now resume, more intense and widespread than before, so that the Italian economy can at last make up the ground lost over the last fifteen years. The firms forced to break off the process by market and financial difficulties and those pondering whether to begin it must not be deprived of the intelligent, prudent and selective support of credit. This is the greatest contribution that the banking system is called upon to make in order to re-launch our economy. | bank of italy | 2,009 | 11 |
Opening address by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, Seminar on Islamic Finance, organized by the Bank of Italy, Rome, 11 November 2009. | Mario Draghi: Islamic finance Opening address by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, Seminar on Islamic Finance, organized by the Bank of Italy, Rome, 11 November 2009. * * * Ladies and gentlemen, I am pleased to welcome you today to this Seminar, organized by Banca d’Italia on the subject of Islamic finance, the component of the financial industry which, complying with Islamic prescriptions, avoids, in particular, the use of interest in financial transactions. This is predicated on the principle that profits should be considered legitimate only upon the condition that they be generated from fully sharing in the business risk of an investment (the so called “profit and loss sharing principle”). Islamic finance has witnessed a rapid expansion over the last decade, with annual growth rates of assets in the range of 10-15 per cent, and a wide dissemination across countries, beyond its traditional centers of gravity in the Middle East and South East Asia. The development of Islamic securities, notably the sukuks, has also contributed to increasing this sector’s activity in international capital markets. Although official statistics are not yet available to accurately measure global developments of the industry, private estimates assess its current size at above $ 800 billion dollars, in terms of intermediated assets, with more than 600 institutions engaged in Islamic finance and operating in around 50 countries; in the last few years, the industry has also been developing in Europe, with the opening of some Islamic banks in the UK, the issuance of a sukuk bond by a German Land, and increased activity in the field of Islamic investment funds management. The growth of Islamic finance in recent years is one aspect of the increased role being played in the global financial system by a number of emerging economies. This is, of course, a welcome development, as it opens up new opportunities for the productive channeling of financial resources both to these countries and other markets. It does, however, also add to the complexity of the global financial system. As the recent crisis has taught us, growing complexity calls for enhanced international cooperation by policymakers and regulators, lest the benefits of a dynamic financial system are jeopardized by instability. The active participation of the monetary authorities of Saudi Arabia and of Indonesia – the country with the largest Muslim population in the world – in the work of the Financial Stability Board is, in this respect, an important contribution to the pursuit of our common goal of a sound global financial system. There can be no effective cooperation, however, without an adequate knowledge of the key features of different components of the financial system, and of their interactions. It is in this spirit that Banca d’Italia has taken the initiative to organize today’s Seminar, with the aim of better understanding the characteristics of this industry and its implications for the financial system in Europe and in Italy. For Banca d’Italia, it is an important opportunity to deepen our knowledge of this subject, in view of its relevance for the Bank’s institutional duties, as a member of the Eurosystem and as the Authority for banking and financial supervision in Italy: we have, therefore, chosen to specifically focus the Seminar on issues pertaining to monetary policy and banking supervision. A cursory look at the program should be sufficient to suggest that Islamic finance and its interactions with conventional financial practices are a source of numerous intriguing questions. I am therefore confident that the subject will stimulate the interest of participants in today’s Seminar, and most grateful to the highly qualified representatives from various monetary and banking authorities, International Institutions, and academia who have accepted to join the three panels. I mentioned the importance of policy cooperation for the safeguard of a sound global financial system. Dr. Zeti Akhtar Aziz, the Governor of Bank Negara Malaysia, who has kindly accepted to be the keynote speaker of today’s Seminar, is an outstanding example of a civil servant who has put international cooperation at the center of her professional activity, throughout her distinguished career: she has, in this respect, chaired the EMEAP’s Taskforce on “Regional Cooperation among Central Banks in Asia” and is currently Chairperson of the BIS Asian Consultative Group. An accomplished economist, she is also one of the leading experts in Islamic Finance, having played a key role in the establishment of the Islamic Financial Services Board, of which she was later Council Chairperson in 2007. Unfortunately, official engagements with the Malaysian government, which were set only in the last few days, have prevented Dr. Zeti Akhtar Aziz from traveling to Europe for this Seminar. While she cannot be physically with us today, she has nevertheless made a point of participating in the event, and has sent us a video recording of her address, which we are now going to show. Let me therefore leave the “virtual” floor to Dr. Akhtar Aziz, looking forward to her address, and to the interesting sessions which will unfold during the day. | bank of italy | 2,009 | 11 |
Address by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the FSB, at the 12th Conference of the ECB-CFS Research Network Learning from the Crisis: Financial Stability, Macroeconomic Policy & Intern. Institutions, Rome, 12 November 2009. | Mario Draghi: Challenges to financial stability and the proposals of the Financial Stability Board Address by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the 12th Conference of the ECB-CFS Research Network “Learning from the Crisis: Financial Stability, Macroeconomic Policy and International Institutions”, hosted by the Einaudi Institute for Economics and Finance, Rome, 12 November 2009. * 1. * * The crisis and the new regulation of finance Conditions in the financial markets have been improving steadily since last spring, but neither risk premiums nor funding costs have come back to their pre-crisis level. At the onset of the crisis it became soon clear that the international community had to work together closely to find a way out of it. It was the first lesson we learnt: before the crisis, governments, regulators, and the financial services industry had for years been affected, in more than one dimension, by a sort of collective and pervasive blindness. The tremendous macroeconomic imbalances that had been accumulating for years, market developments also stemming from regulatory mistakes that had made regulators’ knowledge obsolete, the new and crucial role of intermediaries’ balance sheets for the transmission of monetary policy, were all phenomena that were either ignored or downplayed in their importance. Surprisingly, though it was widely recognized that risk was being priced and trade globally, this did not lead to greater international cooperation in financial regulation. The rapid spread of this devastating financial crisis has vividly demonstrated the power and force of global integration. If banks all over the world over-extend leverage and under-price risk, a mere change in sentiment in the US housing market can be a sufficient catalyst for a widespread collapse in confidence. Market liquidity evaporates, and credit supply contracts as the global financial system comes under severe strain. After the failure of Lehman’s, markets actually froze across the globe, and extraordinary intervention was needed to prevent systemic collapse. World trade slumped as demand plummeted. A “great recession” was inevitable in most advanced countries. Then it was rapidly acknowledged that international co-operation should become an essential feature of the management of this crisis. Financial systems were underpinned by public capital injections, massive exceptional liquidity support and funding guarantees. And there was a widespread loosening of macroeconomic policies. Authorities worked closely together to alleviate particular pressure points, such as the shortage of US dollars in foreign currency swap markets, through the introduction of temporary bilateral swap agreements. And now, as market conditions improve, there is a clear recognition of the need to co-ordinate across countries the exit from support measures, particularly where spillover risks are significant. Clear political leadership for this has been provided by the G20, designated as the premier forum for international economic and financial co-operation. One key objective of such co-operation is to achieve radical changes to the financial system regulation. In an integrated system, where level playing field concerns are very real, this requires international policy development and consistent implementation. In this area, the Financial Stability Board – which I have the privilege of currently chairing – plays a key role. 2. The role of the Financial Stability Board The Board was established earlier this year by the G20 to lead, co-ordinate and monitor progress in strengthening financial regulation and to drive the development and implementation of policies to support global financial stability. It succeeded the Financial Stability Forum, but incorporated a substantial expansion of the membership to include the large emerging economies. And at the same time, the mandate was broadened and enhanced. The strengthened mandate is now enshrined in the FSB Charter that took effect from the Pittsburgh Summit last September. So why do we need a Financial Stability Board? What is the distinctive role the Board plays in strengthening the global financial system? How does the Board work to deliver the key objectives set by the G20 Leaders? And what are the key priorities in the coming months? The strength of the FSB lies in its membership. It brings together in one organization senior level representatives (heads or deputies) from all the relevant actors: regulatory authorities, central banks and finance ministries from 24 jurisdictions spanning the major financial centres across the globe. Indeed, to ensure broad coverage, and thus to improve the effectiveness of policy design and execution, membership is wider than the G20. And these national representatives are joined on the Board by the heads of the key international standard setting bodies and by high-level officials from the major international financial institutions. By harnessing the common aims and collective responsibilities of this membership, the Board is uniquely placed to promote global financial stability. A number of objectives follow. A primary role of the Board is to undertake the diagnosis of regulatory, supervisory and financial policy changes needed to maintain financial stability. To deliver on this, it is our task to ensure that the work of national authorities and the international standard setting bodies is appropriately prioritized, effectively coordinated and focused on the health of the financial system as a system, that gaps in the regulatory agenda are identified and filled, and that overlaps and inconsistencies are avoided. Second, as I will illustrate further below, many financial stability policy goals, such as resolving the “too big to fail” problem, span a wide range of issues that require input, expertise and action from a number of standard setting bodies and national and international agencies. The Board will oversee these multi-dimensional work programmes, to balance the potential solutions from individual work streams, and to offer consistent advice to political leaders on how to develop a strong policy framework. And third, the Board will promote consistent implementation and follow through of agreed policies and standards. 3. Developing financial stability policies A key responsibility – and a starting point for much of the FSB’s work – is to identify sources of vulnerability in the global financial system and how best to reduce them. There are conjunctural as well as structural components to this assessment and, as this crisis has amply demonstrated, these components interact. While we regularly review trends in global financial system to identify areas where risks may be building, our primary focus is the identification of structural weaknesses: market failures, such as the misalignment of incentives, collective action and coordination problems; weaknesses in market infrastructure; and information asymmetries and shortfalls. Such “fault-lines” in the fabric of the financial system highlight the need for regulation and supervision. It is vital that the authorities work closely together to deliver common and consistent solutions to identified system-wide vulnerabilities, given the potential for arbitrage and regulatory competition and the risks of conflicts between uncoordinated national policy objectives. A collective diagnosis is the necessary foundation for a well coordinated and effective response. Following the onset of the financial crisis, an urgent and immediate task of the FSB’s predecessor, the Financial Stability Forum, was to undertake a thorough assessment of the main sources of the crisis, the weaknesses revealed and lessons for policy. In April 2008, the FSF produced a report committing its members to a wide range of concrete actions to strengthen financial system resilience. A further set of recommendations, focusing on ways to reduce the procyclicality of the financial system, to improve co-operation in cross-border crisis management, and to strengthen compensation frameworks, was published in April 2009. Together, our 2008 and 2009 reports were major inputs into the Declarations by Leaders at the Washington and London summits on an action plan to strengthen the financial system. We have since been asked to oversee, drive forward and co-ordinate implementation of the action plan, and strengthen it where needed. The key message is straightforward: we need major changes. We need to build a system which is less leveraged, where capital and liquidity buffers are much stronger, where all institutions or infrastructure capable of posing significant risk are subject to appropriate oversight and safeguards, and where no institution is too big to fail. And we need a systematic effort to reverse the misalignments in incentives that came to characterize part of financial system. All this requires a regulatory and prudential framework which pays much more attention to system-wide interconnections and the health of the global financial network. We consequently need to focus much more on the difficult, but also crucially important, challenges of designing and implementing a macroprudential system of regulation. This will ensure that the financial system is a source of stability that supports the economy under stress, not a source of weakness that amplifies strains and causes major economic damage. In undertaking this collective diagnosis and drawing up a work programme, an important element of the FSB’s role has been to ensure that there is sufficient focus on key areas that cut across the responsibility of different international agencies and groupings. Two good examples, high on the policy agenda, are procyclicality and compensation. There will be major corrective measures to mitigate the procyclical tendencies of the system. Banks will be required to build up a capital buffer during the expansionary phases of the cycle to draw on at times of generalized difficulty. It has already been proposed to mandate a significant increase in the capital charges on trading activities and exposures to securitization instruments. The FSB’s proposals are being addressed within the framework for capital regulation, driven by the Basel Committee; those on provisioning, accounting and valuation issues are taken forward by the accounting standard setters with input from the regulatory community; those on margining practices in securities and OTC derivatives markets are being pursued by the Committee on Payment and Settlement Systems and the Committee on the Global Financial System. We are now entering a critical stage in the regulatory reform process: we have to take some difficult decisions. The Basel Committee will test those affecting the capital framework through a comprehensive impact assessment in 2010, and phase them in as financial and economic conditions improve. Principles on compensation were published in the spring. The FSB followed up with implementation standards in September, which were endorsed by G20 Leaders at the Pittsburgh Summit. The new rules apply to top management and to anyone who has the power to make decisions with a significant impact on the balance sheet of a bank. They provide that a good part of compensation should be variable, dependent on the bank’s performance, but with payment deferred for at least three years and in the form of securities, and with a claw-back clause in the event of unsatisfactory performance by the bank or the executive. The aim of these rules is to counter excessive risk-taking, the pursuit of short-term gain and opacity in compensation. They emphasize disclosure and the control function of the board of directors and the shareholders. Above all, they extend regulatory jurisdiction to the sphere of executive compensation. Action is now urgently required by national authorities and by the standard setters for the banking, securities and insurance industries to implement these principles consistently. A first check on their application is scheduled for March 2010. 4. Rolling back moral hazard risk At the top of our current agenda is the need to resolve the “too big (or too complex/too interconnected) to fail” problem. The problem has been around for years, it has not been addressed and, by objective measures, our actions to save the financial system this time have expanded the problem. The FSB have committed to propose measures to reduce the risks posed by systemically important institutions by October 2010. Work will progress under three broad, complementary approaches. The first is to reduce the probability and impact of failure of a systemically important institution. Options under consideration include strengthening the resilience of the institution through higher prudential requirements, contingent capital, or limitations on higher risk activities, and policies that lessen the impact of failure and the associated contagion risks through constraints on size and/or connectedness. The second approach is to improve the capability of the financial system to deal with failure, through ex ante contingency planning to develop individual de-risking, and through further steps to improve national and international crisis resolution frameworks. The third approach is to strengthen the core financial infrastructure to withstand failure, including through arrangements for central counterparties, OTC contract design and collateralization practices. Given significant differences in financial structures and systems, there is unlikely to be a one size fits all answer to the moral hazard problem. But the underlying challenges and the necessary approaches to them are broadly similar across jurisdictions. Many of the policy approaches discussed have level playing field implications for the structure of international banking and financial activity. We need therefore to ensure that the policies adopted to meet these challenges are consistent and coordinated, do not promote arbitrage that undermines their effectiveness, and do not impose unnecessary constraints that lead to fragmentation of the global financial system. 5. Strengthening policy implementation The FSB have been successful in formulating a common agenda that has gained widespread political endorsement. But that is not enough. Effective, timely and consistent implementation of agreed policies and standards at national level is essential: first, to resolve collective action and coordination problems; second, to prevent harmful arbitrage, spillovers and regulatory competition; and third, to preserve the benefits of a level playing field across the global financial system. It is ultimately up to the national supervisors and regulators to implement the measures they agreed upon within the FSB. Responsibility for the surveillance on the actual implementation belongs to the IMF. However, one should also underline that all 24 member authorities have committed in the FSB Charter to implement international financial standards, and to undergo periodic peer reviews of their adherence. These peer reviews will be of two kinds – country on country reviews, and thematic reviews which examine implementation of agreed policies in a given area across the membership. We will begin conducting peer reviews in January, starting with a review of the implementation of the FSB’s Principles for Compensation that I spoke about earlier. More generally, to further bolster international consistency in rulemaking, our members will participate in an information network to monitor the national implementation of all new measures agreed by the FSB and G20 to strengthen global financial stability. That network will be drawn on in future thematic reviews. The FSB aims to lead by example to strengthen observance of international financial standards across the globe. Independent, published, peer reviews of implementation of standards within member jurisdictions will encourage a “race to the top” in terms of adherence. They will also reinforce the credibility of the FSB. 6. Concluding remarks International cooperation has limited the economic impact of the crisis, avoiding the worst scenarios. Still, difficult challenges lie ahead of us: how to recover a balanced, sustainable growth path; how to build a new financial regulatory framework that reflects the lessons drawn from the crisis. The FSB has been created to improve the design and implementation of financial policies across the globe. The current framework has been shown to be seriously wanting and has posed enormous economic costs. It is consequently vital that authorities diagnose the current problems thoroughly and take bold and radical action to remedy the current deficiencies. The need to strengthen the resilience and robustness of the global financial system is clear and paramount. There is a major work programme ahead for international regulatory bodies, for national authorities, for the IMF and for the Financial Stability Board itself. In many areas, such as the “too big to fail” problem, there will be no easy answers. In others, such as introducing a macro-prudential or systemic approach to financial regulation, both academic and policy thinking is still at an early stage. And as the situation improves, the power of vested interests contrary to any substantive reform gets stronger. Nevertheless, we must take action in the near term in all areas. Can we prevent the next crisis? Almost by definition of the word “crisis” the response to this question is bound to be negative, but what we can and should do is to make our financial system more resilient when the next crisis will hit it. After all we have shown that we are able to learn from experience. This crisis had all the potential to generate the same devastation as in 1929, but this time both the structure of the real economies was more robust, and the policy reaction was more perceptive and eventually successful. | bank of italy | 2,009 | 11 |
Remarks by Mr Giovanni Carosio, Deputy Director General of the Bank of Italy, at the International Conference of Remittances, G8 Global Remittances Working Group plenary meeting, Rome, 9 November 2009. | Giovanni Carosio: Global remittances Remarks by Mr Giovanni Carosio, Deputy Director General of the Bank of Italy, at the International Conference of Remittances, G8 Global Remittances Working Group plenary meeting, Rome, 9 November 2009. * * * Immigrant workers’ remittances are a substantial component of international financial flows. The total inflow to developing countries in 2008 is estimated at $330 billion, up 15 per cent on 2007 and twice as much as in 2004. This amount is more than three times the volume of aggregate official development assistance and three times net private debt inflows. That remittances can be a powerful lever for economic development is demonstrated not only by economic theory but by economic history. Take the case of Italy. In both periods of exceptionally rapid growth (1895–1913 and 1950–1970), remittances were a crucial factor, eliminating the external constraint. In more recent times, Italian emigration has waned, and Italy – historically a source of emigration – has become an increasingly attractive destination for migrants (since the late 1980s immigration has regularly outweighed emigration). Since 1999, Italy has recorded a net outflow of migrants’ remittances. The Heads of State and Government of the G8 countries, which are the main remittancesending economies, first dealt with remittances at the Sea Island Summit in 2004. Since then, a number of initiatives have been taken to improve information on remittance flows, to facilitate transfers and reduce fees, to ensure the safety and integrity of financial flows and to enhance their developmental impact. From the very start the Bank of Italy has contributed to this agenda, since most of the G8 goals in this sphere fall within the Bank’s institutional mandate. In the last four years, for instance, our research department has produced papers on the role of remittances in the Mediterranean countries, their impact on output growth volatility and their effects on external payments crises. As to balance-of-payments statistics, the Bank of Italy has contributed to the international effort to harmonize statistical concepts and definitions and to improve data collection methodologies. In 2006 the Bank introduced a new data gathering system based on information from money transfer operators on customers’ gross remittance transfers. The new system has greatly improved data quality and is a methodological landmark internationally. In the course of this year the G8 authorities have focused their work on immediate solutions to apply the first of the General Principles for International Remittances Services, namely: “The market for remittances should be transparent and have adequate consumer protection”. In line with this principle, many countries are developing national remittance price comparison databases in order to increase market transparency, providing information to migrants who want to send money home that should enable them to acquire the information essential to informed choice. At present the market for remittances is not always fully transparent. Two issues are particularly relevant: total price and speed of service. The cost of a money transfer is not actually easy to calculate due to two variable components, i.e. transfer fee and exchange rate. Consequently, the consumer may not know exactly the amount of money the receiver will get. The difficulty is compounded for migrants, who due to poor financial education, language barriers and time constraints, may have difficulty in accessing certain services, in particular bank services. This may result in the impossibility of comparing alternative remittances services and finding the most economical. The ready availability of information fosters competitive markets, as demand will tend to concentrate on the most efficient remittance service providers, those offering quick service at lower cost. The national websites compliant with the World Bank standards provide all the information required for informed decisions: the fees charged, the exchange rate applied and the time necessary for the money to be available. The Bank of Italy welcomes the creation of a national price comparison website and will support its management, facilitating data collection and providing information on the most significant corridors and on the latest updates in the retail payment market. This initiative is consistent with the overall approach taken by the Bank in performing payment system oversight, whose aim is to promote efficiency. In this particular market efficiency is all the more important in view of the enormous impact that remittances may have on the economy of an emerging country. The analysis of the pricing of a payment instrument is one of the key indicators of a market’s performance: when the price reflects the cost of the payment instrument, the market is efficient. Efficient funds transfer, with no waste of time or money, enables migrants to channel their earnings to productive ends. In Italy the regulatory framework on transparency in the payment market will be enhanced by the Payment Services Directive. The objectives of the new legal framework are to heighten competition in the retail payment market, strengthen user protection and develop more efficient payment services. A special set of provisions is dedicated to transparency: the two main lines of action are elimination of non-explicit price mechanisms and achievement of greater certainty on the terms applied in the supply of payment services. National legislation has to transpose the obligations laid down under these provisions with regard to “two-leg” transactions only, those in which both payment service providers (if there are more than one) are located within the EEA. But Italy has opted for broader scope, extending the transparency rules also to one-leg transactions in which only one of the service providers is located in the EEA. The information requirements concern both the conditions of the service (ex ante transparency) and the effective execution of the transaction (ex post transparency). They vary with the nature of the payment service contract and the needs of the customer. A new category of payment service provider is also envisaged by the Directive: the “payment institution”. This represents an opportunity for businesses with a network structure and extensive distribution channels, such as mobile phone operators and large retailers, who will be subjected to rules laid down by the oversight authorities to ensure adequate quality of payment services. It goes without saying that the new regime will benefit remittances. The Bank of Italy also monitors technological innovation in the remittances market. A study the Bank is currently conducting on mobile payments has found that most operators are interested in developing new remittance payment services using mobile phones. In fact, in the emerging countries mobile phones are already being used successfully to transfer money internationally. In the opinion of the mobile phone operators interviewed, in the medium-tolong term it will be possible to deploy mobile payments applications for remittances on a large scale in Italy as well. To conclude, a number of initiatives in both the regulatory environment and the market may have a significant impact on the remittances industry, increasing transparency and efficiency. The Bank will continue to support these initiatives while monitoring the remittances market as part of its institutional mandate for oversight on the payment system, economic research and supervision of financial institutions. In view of the social and economic impact that remittances have on the everyday life of migrants and the increasing attention of the G8 authorities, we hope that along the lines of this Italian initiative, and of those in other countries, remittance price databases will be introduced in many countries around the globe. | bank of italy | 2,009 | 12 |
Address by Mr Giovanni Carosio, Deputy Director General of the Bank of Italy, at the conference "Carte 2009 - Cards Revolution", organized by the Italian Banking Association, Rome, 12 November 2009. | Giovanni Carosio: Payment cards between the Payment Services Directive (PSD) and the Single Euro Payments Area (SEPA) Address by Mr Giovanni Carosio, Deputy Director General of the Bank of Italy, at the conference “Carte 2009 – Cards Revolution”, organized by the Italian Banking Association, Rome, 12 November 2009. * * * Preamble The integration of the European retail payments industry has entered a phase of rapid progress, spurred by the regulatory changes contained in the Payment Services Directive (PSD), the Single Euro Payments Area (SEPA) project for cooperation between public and private sectors, and the introduction of new electronic instruments for payment services. The implementation of the Directive will have a strong impact on competition in the payments industry, stimulating the creation of new instruments and the access of new operators to the market; the migration from national to harmonized SEPA products will give fresh opportunities to service users for comparing instruments and making better informed decisions. Both these developments necessitate an in-depth review of the current product supply mechanisms and are therefore a driver of the operational and technological change already in incubation. These dynamics are reflected, and in many ways magnified, in the payment cards market; cards are seen as the natural substitute for cash and thus the instrument that more than any other can shift consumers’ habits towards efficient and secure payment services. Card circuits describe a skein of relationships between a multiplicity of actors whose interests, while not diametrically opposed, do not immediately coincide; ensuring efficiency is therefore a complex objective. A balance must be struck between the needs of the various stakeholders, involving the safeguarding of competition, the profitability of the services offered and the security of the instruments used. Payment security is the defining element in dealings with customers; traditionally, it is the cornerstone of the fiduciary relationship between savers and financial intermediaries. It must also be guaranteed in the new “virtual” realities; the dangers inherent in the new technologies require harmonized technical and legislative measures that the European standards can provide. As the market continues to suffer from the financial crisis, the growth potential of the payment card sector remains enormous in countries such as Italy, where cash transactions are still predominant. Economic conditions Developments in the retail payment services market have been affected by the financial crisis and unfavourable cyclical conditions. Since the second half of 2008 global growth in the payment instruments market has declined, a trend apparent in Italy too; cards, however, and in particular pre-paid cards, appear to have weathered the storm best. The annual growth of card transactions at Italian POS terminals (5% in 2008; 7% in 2007) was higher than that for other instruments (1 % in 2008; 3% in 2007) and broadly in line with the European trend. Pre-paid cards continue to be the best performing instrument, with an annual average growth rate of 50 per cent, five times the European rate. In 2009, while the volume of other payment instruments (credit transfers, direct debits and cheques) declined by around 2%, the payment cards market continued to grow at broadly the same pace as in 2008. The growth rate for pre-paid cards also declined, from 50 to 25 per cent. These are the conditions in which the payments industry is opening up to new actors equipped to offer innovative products – such as mobile payments – capable of rapidly gaining market share, especially in micro-payments where cash is so common. Some evidence of this can be seen in the case of pre-paid cards (also thanks to their use in Internet transactions) and other new instruments (for example, motorway toll payment devices). Indeed, several studies show that even in countries with advanced credit and debit card systems, cash payments still predominate for transactions below a certain amount, estimated at around €15; in Italy, however, this threshold continues to be considerably higher (around €40), confirming the traditional preference for cash. In view of the many applications that can be combined with the pre-paid function for recurring expenses (rather than with the traditional current account), the micro-payments area appears particularly suited to policies for greater mobile payments coverage – the natural next step of the most advanced products in the world of cards such as “contactless” cards. The nexus between the cyclical situation and the creation of new market segments lies in the delicate nature of the strategic choices that banks must make. More investment in new sectors, more risks relative to the speed at which such investment can be amortized when profits are lean, but at the same time the need to address the contraction underway in many areas of the financial industry. The payment services directive and other community regulations On 28 October the Council of Ministers approved the draft legislative decree transposing the PSD into Italian law. The text is now before Parliament. Within 45 days the competent committees will issue their non-binding opinions, before definitive approval by the Council of Ministers and publication in the Gazzetta Ufficiale. The first set of rules laid down in the Directive concerns the rights and obligations of the parties to payment transactions (Title II). By harmonizing the rules, these provisions remove the obstacles to uniform use of SEPA schemes everywhere in the European Union. These are rules that affect the ways in which payment services are actually provided, the structure of transactions, and the responsibilities of the various parties. They are designed to guarantee the highest possible level of security and protection for users of payment services and to foster efficiency and innovation. The PSD will have a powerful impact on payment cards, owing in part to specific provisions of Italy’s transposition decree, which characterize its content with respect to the general provisions of the Directive. Some of these national “qualifications” are distinguished by the objective of enhancing guarantees for users, in order to strengthen confidence in advanced, non-cash instruments. For instance, the decree recognizes the need to adapt some of the PSD’s general clauses (as in the case of compatibility of cost-sharing with interchange fees) and offers incentives for the use of the most secure, technologically advanced instruments. From this standpoint, one noteworthy feature is the possibility for the merchant to offer discounts to customers who use only the electronic payment instruments covered by the decree. Further, in order to promote the use of more efficient and reliable instruments, the Bank of Italy can authorize merchants to make it more costly for customers to use the less efficient instruments, in derogation to the general “no surcharge rule” that the circuits impose on merchants to prevent discrimination against their cards. In any case, the aim of promoting the most advanced forms of payment is not exclusive to the PSD but runs throughout recent Community regulations. The Electronic Money Directive, whose transposition is scheduled for the end of April 2011, represents in some respects an extension of the PSD. It modifies the concept of e-money to embrace all the different possible forms (card-based and server-based) and allows future electronic money institutions to do business under a regime analogous to that covering payment institutions under the PSD, as regards both the types of activities they can engage in and the possibility of combining payment and commercial services. This could produce a fully competitive market situation, propitious to the rapid technological advance of the competitive frontier, with direct benefits for the quality of services. Another feature of the overall reform of European payment regulations is the aim of ensuring effective protection for payment service users by designating an authority with specific powers of control, complaints handling, and sanctions; for our country, the authority will be the Bank of Italy. These new responsibilities are grafted onto the payment system oversight powers of the Bank under Article 146 of the Consolidated Law on Banking, which the PSD transposition decree amends to make user protection an express objective along with the traditional ones of efficiency and reliability; the regulatory and control powers that the Bank needs to perform this function effectively are specified. SEPA and payment cards The authorities (the Eurosystem, the Commission) and the market organizations (e.g. the European Payments Council) have long since agreed that the basic approach to SEPA as regards payment cards must rest on varied, ramified models of integration: adequate governance of pan-European schemes; transparent, non-restrictive business models (and fee mechanisms); and higher operational standards for security and processing. The greatest progress has come in raising standards, as is shown by the migration to smart cards – microchip technology is now installed on some 80 per cent of card acceptance devices – which has produced encouraging data on payment card frauds, as well as further advancing the relatively high degree of technological integration that has historically marked the payment card industry internationally. There should soon also be an acceleration of convergence of fee mechanisms thanks in part to the progress being made in the debate on the multilateral interchange fee (MIF). The measures affecting governance and the creation of pan-European alternatives to the Visa and Mastercard circuits have been less significant. Although some interesting initiatives have been taken under the logic of “federating” the national debit card circuits (e.g. EAPS, Payfair, Monnet), by far the most prevalent approach still remains co-branding with the international circuits. In this context, further gains in efficiency can be sought by separating the governance of the schemes (domestic or international) from payment processing, thus increasing the transparent supply of unbundled services that are not binding upon users and should therefore foster the ability to select the most efficient structure. The integration process is being closely followed by the Eurosystem as payment instrument overseer. The approach is designed to verify the circuits’ level of efficiency and technicaloperational security. Efficiency To achieve real advances in card scheme efficiency and fee profiles, the debate on the Multilateral Interchange Fee and its relationship with the effective costs of instrument acceptance (also from the standpoint of the “war on cash”) remains crucial. The MIF, preset for each circuit, is relevant both to interbank and to bank-customer transactions as a component of the final price. According to the European competition authority, the MIF constitutes a de facto lower limit to the service fees charged to merchants on debit, credit and prepaid card transactions. However, the theoretical literature is not at all unanimous on the effects of multilateral interchange fees, and empirical studies are of little help. This suggests the need for a prudent approach, with case-by-case evaluation before any decision for substantial intervention on payment network mechanisms is made. This is the necessity that has shaped the Commission’s recent initiatives to find a practical method for setting the interchange fee at an efficient level that truly takes account of the costs (and the benefits) of accepting a card in lieu of other instruments (especially cash) at points of sale – the so-called “tourist test”. The aim is twofold: to help guide the European competition authority in assessing compliance of cross-border MIFs with the EU Treaty and to stimulate convergence of fees for SEPA card use by applying the new method to national circuits. The Eurosystem too has undertaken a study on the costs of using various payment instruments and cash, in order to measure the potential savings to the economy of replacing the more costly instruments with those considered more efficient. The survey will permit comparisons between countries and instruments (for instance, calculating threshold levels that make it economic to choose any given instrument) and to highlight the effects of technological innovation. The debate on the MIF and, more in general, on the fee structure of payment networks must not obscure the objective of expanding electronic payments and reducing the use of cash in retail payments. The MIF covers a significant part of the costs sustained by the issuer (brand management, technological innovation, clearing, authorizations, revocations) and can therefore serve to avoid levying a charge directly on the cardholder. Indeed, in order to encourage the use of cards, the MIF structure posits that the holder is to be exempt from charges upon making purchases; this argument is completed on the normative plane with the PSD’s surcharge rule, also incorporated into the Italian government’s draft legislative decree. Although it goes beyond the debate on the MIF, another important explicit recommendation of the Eurosystem and the European competition authority that can enhance the efficiency and competitiveness of the system in the SEPA process is the adoption of “open” fee structures. The aim is to give merchants ample room for choice in negotiating acceptance fees differentiated by instrument (for example, prepaid card or credit card) and circuit (for instance, PagoBANCOMAT and Maestro), thereby undoing the widespread practice of blending the rates on transactions with different cards even under competing schemes. This is an approach that has found a counterpart at national level in the action of the Bank of Italy and the Antitrust Authority to open up the market to the new “multi-bank” technologies that allow transactions carried out at a POS to be transmitted for settlement to a selection of banks rather than to a single reference bank, in order to enable merchants to negotiate fees on a competitive basis. Security The other key feature for the adequacy of card circuits within the SEPA context is security, i.e. a scheme’s capacity to reduce the risks of fraudulent or illicit use of payment instruments. As I noted earlier, the overall incidence of fraud is declining thanks to the changes connected with the migration to SEPA. The ratio of fraudulent to total transactions carried out with debit, credit or prepaid cards now stands at 0.05 per cent in Italy, in line with the international standards and down from the peak of 0.07 per cent in 2006. The improvement is surely due to faster replacement of cards that only have a magnetic stripe with cards equipped with an EMV chip, in compliance with the common standard for SEPA and for the international card circuits. A factor contributing to this result has been the action of the Bank of Italy in its oversight function to encourage circuit operators to adopt technologically more secure devices as swiftly as possible, consistent with the expectations of SEPA, accompanied by the application of mechanisms aimed at shifting the pecuniary liability for losses caused by fraud to the operators that are non-compliant with the new security standards. Among payment cards, prepaid cards have lower rates of fraud (0.02 per cent), which has evidently favoured their popularity. Renewed threats are being posed especially for online transactions: cases of phishing and hacking to acquire sensitive personal data for the illegal use of payment instruments are on the rise. Strengthening users’ confidence requires preventive action, with recourse to new technologies and to incentive mechanisms (such as “liability shift” clauses) that have produced good results in the world of “physical” payments and can be enhanced and extended to the virtual world. The PSD’s provisions on issuer liability also move in that direction and should spur the banking system to invest new resources in preventive technologies. For Internet payments in particular, the risk of fraud should be reduced by widespread adoption of central authentication systems, with the use of two or more access keys, security tokens and one-time passwords, as well as specific site data protection programs. The bodies promoting the SEPA project can intervene more effectively in these respects with shared rules of conduct. The theme of security includes measures to prevent use of payment instruments for illegal purposes such as money laundering. The objective of the various authorities is to combine operational flexibility and technological development in the field of payment services with adequate integrity of circuits and traceability of transactions. In this sense, the scope for marketing anonymous products, both single-load and reloadable, under the new legislative context is limited both in the maximum amount that they can handle and in their function capabilities, especially for so-called card-to-card transfers. In a globalized market, fraudulent activities can rapidly reposition themselves and concentrate on the weak links of the chain. For this as well as for other reasons, it is important that intermediaries (banks, issuers and all operators in the sector) not merely comply formally with the rules but take a risk-based approach in setting corporate policies to prevent improper use of instruments and circuits, with the associated risk of severe reputational repercussions, which can undermine customer confidence not only in the entities involved but in the payment instruments and circuits themselves. Conclusion Considering the still very high level of use to cash, Italy is among the countries that stand to benefit most from the integration under way in the European market in payment cards. The completion of the new legislative framework creates the conditions for the market to offer highly standardized , technologically advanced products that can capture a mass customer base, such as persons making micro-payments. For their extensive distribution and user friendliness, payment cards are able to make the most of technological innovation, including through both cooperative and competitive interaction with the new service providers coming into the market, such as mobile telephone service operators; this can make it possible to attack the threshold of micro-payments with services that are really alternative to cash. The payment system oversight function intends to accompany this development, by involving all the stakeholders in defining instruments, services and solutions that can enhance the reliability and efficiency of the payment system. | bank of italy | 2,009 | 12 |
Distinguished lecture by Mr Ignazio Visco, Deputy Director General of the Bank of Italy, at the XVIII International "Tor Vergata" Conference on "Money, Banking, and Finance", Rome, 4 December 2009. | Ignazio Visco: Global imbalances in the financial crisis and the international monetary system Distinguished lecture by Mr Ignazio Visco, Deputy Director General of the Bank of Italy, at the XVIII International “Tor Vergata” Conference on “Money, Banking, and Finance”, Rome, 4 December 2009. * * * In the preparation of this speech I have benefited of extensive discussions with Pietro Catte and Patrizio Pagano. I am solely responsible, however, of the views here presented. The financial crisis and its macroeconomic roots Even though the crisis caught a large part of the economics profession by surprise, this was not because economists and policy makers had entirely failed to notice the growing elements of vulnerability in the foundations of the global economic expansion. Before the crisis, many of them had identified the risk of a hard landing for the US economy, but in most cases they saw it as originating in the unsustainable US current account imbalance, which might eventually lead to a disorderly dollar depreciation. As it turned out, the trigger of the global financial crisis and its proximate causes were essentially financial in nature, and originated in a specific segment of US financial markets. However, I don’t think that the fundamental sources of vulnerability for the world economy had been wrongly identified. Even though the proximate causes of the crisis lie in previous financial excesses, I would suggest these would not have developed to the same extent had the macroeconomic environment not been characterised by large saving-investment imbalances, very low interest rates and asset price misalignments. These factors created enormous stress for a US and global financial system in which innovations and regulatory failures had progressively introduced serious structural flaws. It may also be argued that the complacency on the part of risk managers and financial supervisors that allowed financial vulnerabilities to grow unchecked owed much to the climate of general optimism that those macro conditions supported. And when we look at how a local financial crisis propagated rapidly across markets, not just in industrialized countries but globally, and then triggered a global recession, it is also clear that only a much broader set of interrelated factors – macroeconomic as well as financial – could have generated a crisis of these proportions. Over the 10–15 years that preceded the crisis, it was already possible to identify a number of signals of macroeconomic stress, which interacted with financial system flaws to build up very significant, although at the time partly hidden, financial fragilities 1: – the dramatic fall in US households’ saving rate, from around 7 percent in the early 1990s to close to zero in 2005–2007; – a very large increase in US and global liquidity, also reflecting the generally accommodating US monetary conditions; – the widening of global imbalances, recognised as unsustainable already in the late 1990s; A more extensive discussion of these macroeconomic developments can be found in a previous paper presented this spring to a G20 Workshop (see I. Visco, “The global crisis: the role of policies and the international monetary system”, in G20 Workshop on the Global Economy, Macroeconomic causes of the crisis: Key lessons, Mumbai, India, 24–26 May 2009, pp. 60–80, available at http://www.g20.org/Documents/g20_workshop_causes_of_the_crisis.pdf. – an enormous increase in official reserves, largely concentrated in emerging Asia and the oil exporting countries, which mostly pegged their currencies to the US dollar; – very low levels of global long-term interest rates and asset price volatility after 2003; – a sequence of asset price bubbles, in the United States and globally, most notably the dot.com equity bubble of the late 1990s, followed by an unusually synchronised global housing price boom. Essentially, these disequilibria reflected rapid and sustained growth in final demand, especially consumption demand, in the United States, financed by over-borrowing, and ultimately by borrowing from abroad. This happened against a background of abundant saving in the rest of the world, especially in Asia; excess savings at the global level tended to compress real interest rates to abnormally low levels when compared to average GDP growth. If the United States served as a sort of “consumer of last resort,” other large advanced and emerging economies implicitly or explicitly followed an export-led growth strategy, which is difficult to maintain indefinitely but also difficult to abandon. 2. The role of policies Policies had a non-negligible role in sustaining this pattern of unbalanced growth. To illustrate their role in building up the conditions that eventually led to the global recession, a recapitulation of the sequence of events that have marked the last ten to fifteen years, condensed in the following six statements, might be useful: 1) Around the mid-1990s, the acceleration of US productivity associated with the ICT revolution and the increase in household net worth due to rising equity prices determined a first upward shift in private sector propensities to invest and to consume. 2) The US monetary policy stance generally accommodated the hype in the “new economy” in the late 1990s; by historical standards it was particularly easy for a prolonged period after the bursting of the dot-com bubble. 3) By sustaining US domestic demand, the hype in the “new economy” and the expansionary monetary (and fiscal) stance contributed to an unsustainable widening of the US external imbalance, compensated by growing imbalances of opposite sign in the external positions of major emerging economies, especially after the Asian crisis of 1997–98. 4) A number of Asian and oil exporting countries that pegged their currencies to the US dollar accumulated very substantial official reserves. The investment of these in US Treasury paper contributed to lower long-term interest rates. 5) Low interest rates triggered a search for yield which, by squeezing risk premiums, tended to make financial conditions even more favourable for a broad range of borrowers. Low perceived risk, abundant liquidity and credit expansion, as well as regulatory failures in some markets, helped feed the house price bubble. 6) Eventually, global supply reached bottlenecks in the form of commodity supply constraints, US monetary policy was gradually tightened, and house prices peaked. At that point, the large risk exposures that had accumulated in the financial system suddenly became apparent, precipitating the turmoil. As it is clear from this brief and very simplified overview, two central elements of the story are: (a) an overly expansionary US monetary policy, which permitted a long expansion of consumer spending financed by growing indebtedness; (b) the choice by China and other emerging countries to follow an export-led growth strategy supported by pegging currency to the US dollar, resulting in the accumulation of large official reserves. Both policies were attractive in the short run, but ultimately unsustainable in the long run. In order to understand what allowed them to be maintained for such a long time we need, first, to review the conceptual setup that has been used to frame and to assess monetary policy choices, including the role (at best a secondary one) assigned to asset price and financial stability among the responsibilities of central banks. Secondly, we have to reassess the functioning of the existing international monetary system, asking in particular why it did not effectively induce the correction of the imbalances and promote policies conducive to the orderly functioning of the world economy. 3. The limits of the existing policy setup 3.1 Monetary policy It has been convincingly argued that as a result of the success achieved by macrostabilisation policies and of structural changes in the responsiveness of aggregate supply (also as a result of globalisation), inflation expectations are now much better anchored, and episodes of excess creation of liquidity and credit tend to be reflected primarily in asset price bubbles, rather than in increased consumer price inflation. The task of monetary policy in this context is not necessarily easier. Because asset price cycles tend to be associated with large changes in indebtedness and add to financial vulnerabilities, they can pose significant risks to financial stability, and therefore interfere with the achievement of macroeconomic stability. The relevant question is probably not whether monetary policy should target more than just consumer price inflation – it probably could not, with just a single policy instrument – but rather whether it should react to information on asset price misalignments and financial imbalances in the context of a flexible inflation-targeting (or equivalent) framework. The standard answer to this question – that asset prices and financial imbalances will normally be taken into account insofar as they impinge on the central bank’s objective of price stability – is not very satisfactory in practice. Such frameworks rely on forecasts, whose precision can only decline as we move to more distant time horizons. The models we use to interpret economic data and to set policy are particularly lacking in the treatment of asset prices. In particular, we do not know enough about the effects of asset price misalignments and related imbalances, and also econometric estimates have trouble capturing rare “extreme events”. Many of the effects associated with asset price imbalances are, anyway, likely to be highly non-linear and complex. Although there is a growing consensus that central banks need to monitor risks to financial stability and to take them into account in the conduct of monetary policy, we still lack a theory of how this can be done in practice. Trying to balance such risks, whose potential size, shape and time horizon are extremely uncertain, against the other, more standard sources of risks to price stability involves a particularly difficult kind of trade-off. To improve the terms of this trade-off it is essential to proceed decisively with the reforms of financial regulation and supervision already outlined by the Financial Stability Board and the Basel Committee. The aim of these reforms is to correct the serious incentive distortions revealed by the crisis and, in this way, to make financial systems both more resilient and less pro-cyclical. Important gains in the direction of addressing the twin objectives of price and financial stability not only with the instruments of monetary policy can probably be achieved by developing macroprudential policy tools. 2 3.2 The international monetary system The US monetary expansion and China’s exchange rate pegging could be maintained for so long because they were mutually reinforcing. Demand from US consumers helped sustain China’s (and other countries’) export growth. At the same time, an elastic supply of cheap imports from Asia helped keep inflation low in the United States, encouraging the Fed to maintain an easy monetary stance. And the investment of emerging economies’ official reserves in US Treasuries contributed to compress long-term yields both in the United States and globally. All this fed global liquidity and rising asset prices. The countries that pegged their currencies to the dollar effectively imported US monetary policy, regardless of whether it was appropriate for domestic conditions. This fuelled liquidity and credit expansion, also because of difficulties in sterilizing the effects of the accumulation of official reserves, and tended to feed booms in domestic asset prices and investment. Other surplus countries also had a responsibility in allowing the imbalances to grow. In Japan, long delays in facing up to the structural problems of the financial sector caused a prolonged stagnation of demand. In Germany and other European countries the labour market reforms introduced in recent years, in the absence of equally forceful reforms in product markets, have largely translated into stagnating wages and weak domestic demand. Even though the imbalances were not sustainable, there was no effective mechanism – market-based or activated by multilateral surveillance – to induce a correction. On the one hand, by pegging their currencies to the US dollar, surplus countries managed to avoid pressure to adjust. On the other hand, the role of the US dollar as the international reserve currency (the “exorbitant privilege”) implied that the United States could finance persistent current account deficits without coming under market pressure, as long as the surplus countries were willing to accumulate dollar assets. Having US external liabilities denominated in dollars and international assets mostly in foreign currencies had the additional advantage that the US net investment position improved when the dollar depreciated. Although the international monetary system based on the “dollar standard” has not been performing some of its essential functions, it is by no means clear what could replace it. All those that have been mentioned – a supranational currency like the SDR; a tripolar system based on the dollar, the euro and an Asian currency – face very substantial difficulties. Underlying all this is the fact that the international monetary system that emerged after the demise of Bretton Woods is a “non-system”, driven by the revealed exchange rate preferences of the individual countries, with a very weak multilateral surveillance, despite recent attempts to strengthen it. The regime of fixed exchange rate pegs was never replaced by one of generalised free floating, but instead gave way to a hybrid system. In practice, throughout the last 35 years, the exchange rate policies of a majority of countries have been marked by widespread “fear of floating”, with large foreign exchange intervention. This fear is not at all surprising, since large exchange rate fluctuations driven by capital flows can be highly disruptive in a world that is increasingly integrated economically and financially 3. A broad and lively debate on the design of such tools has recently developed. See, for example, the paper by C. Borio on “Implementing the macroprudential approach to financial regulation and supervision” (published in Banque de France Financial Stability Review, September 2009), the discussion paper by the Bank of England (“The role of macroprudential policy”, Discussion paper, November 2009) and the report of the Warwick Commission on International Financial Reform (The Report of the Second Warwick Commission Report: In praise of unlevel playing fields, November 2009). See also, on these issues, I. Visco, “The global crisis: The role of policies and the international monetary system”, cit. 4. The main challenges ahead 4.1 Correcting global imbalances and fostering sustainable growth Whatever the shape of the future system, an urgent task – to be addressed as soon as the economic situation improves – is correcting existing imbalances. The fundamental macroeconomic imbalances that lay at the root of the financial crisis are not being righted by the consequent global recession. At present, the rise in US private sector saving and the sharp fall in investment, partly offset by a larger public sector deficit, appear to have narrowed the US current account deficit from 5.3 per cent of GDP in 2007 to 2.6 per cent in 2009, as projected by the IMF. However, most of the reduction is due to cyclical, not structural, factors; the effect of lower oil prices should also be seen as essentially cyclical (Figures 1 and 2). Moreover, exchange rate movements have not generally supported the correction of imbalances. The dollar first depreciated until July 2008, then appreciated by 20 per cent in effective terms until March 2009, as the turmoil engendered demand for dollar liquidity and large capital flows out of emerging markets sought a safe haven in US Treasury securities. Those flows were then reversed as investors’ flight to safety abated and the financial situation normalised, and the dollar has accordingly started depreciating again, returning approximately where it was in July 2007 (Figure 3). What happens as the world economy comes out of the recession depends largely on what drives the recovery: if it is an expansion of demand in the surplus countries – including not only emerging Asia, but also Japan and some European countries – some real correction of imbalances is possible; but if the world again relies on US consumers as the primary source of demand growth, then imbalances will widen once more. There is now a growing awareness of the importance of rebalancing global demand in order to achieve a more sustainable pattern of growth. The joint statement released in September of this year following the G20 summit in Pittsburgh acknowledges that: “ensuring a strong recovery will necessitate adjustments across different parts of the global economy, while requiring macroeconomic policies that promote adequate and balanced global demand as well as decisive progress on structural reforms that foster private domestic demand, narrow the global development gap, and strengthen long-run growth potential.” However, it is still not evident how (and whether) each country will in fact implement such shared understanding. In China, a shift toward greater reliance on domestic demand – and particularly consumption – will require increased public spending on health and social safety nets, which can encourage a lower precautionary saving, as well as reforms in the governance of public enterprises. In Europe, potential output needs to grow faster so as to allow for higher growth in domestic demand without jeopardizing price stability. Japan similarly needs to boost productivity and domestic demand. In both regions, this will clearly be a substantial challenge, requiring a renewed emphasis on structural reforms. If economies were able to achieve a major rebalancing of global demand from deficit to surplus countries, while allowing for a full and sustainable recovery of world economic growth, exchange rates would probably have to move as well, reflecting such structural adjustments. But unless the shifts in underlying saving and investment flows are sufficiently large and sustained to make a substantial contribution to the correction of imbalances, the expectation may grow that a large exchange rate correction of the US dollar against the currencies of surplus countries will eventually be required. This could trigger disorderly exchange rate movements. Such a scenario would pose a very difficult challenge to the countries, such as China, that have accumulated large quantities of official reserves, predominantly in US dollars. However, continuing to peg their currencies will only postpone the day of reckoning, while increasing the potential capital losses. This dilemma is exacerbated by the fact that a country that acted alone in allowing its currency to appreciate would stand to lose significantly in terms of trade competitiveness. This is a classic case in which collective action, if feasible, would be welfare-improving. It might take the form of a cooperative agreement among Asian surplus countries for some kind of joint “managed currency appreciation”. The boost to domestic demand (and the associated real appreciation) would have to be large enough to ensure a significant correction of imbalances. But we also need a mechanism to maintain orderly exchange rate movements while the rebalancing of global demand is carried out. 4 The solution is unlikely to consist in simply asking the countries with dollar peg regimes to shift abruptly to full exchange rate flexibility. Equally unrealistic would be its polar opposite, a “world currency”, which would require a very high degree of price and wage flexibility. I think that pragmatic solutions based on intermediate regimes, such as target zones or bands and currency baskets, should not be dismissed out of hand. 4.2 Exit strategies: supporting the recovery without creating new sources of financial instability At present, the main priority of monetary and fiscal policies in all advanced countries and in many emerging ones is still to support the economic recovery by offsetting the weakness in private consumption and investment demand and the effects of financial sector deleveraging. However, the focus of the policy discussion has already shifted to the issue of when and how to unwind the exceptional monetary and fiscal stimulus. In fact, policy makers are well aware that such exceptional measures, if maintained too long, could become new sources of instability. One source of risks is the huge accumulation of public debt, which could potentially lead to a higher cost of borrowing if markets were to become concerned about its sustainability. The IMF has estimated that government debt in G-20 countries will reach 118 per cent of GDP in 2014, and that lowering it to 60 per cent by 2030 would require an improvement in structural primary balances by 8 percentage points of GDP (Figures 4 and 5). 5 Achieving shifts of these proportions will involve tough policy choices. In particular, facing the challenges posed in most countries by the projected rise in age-related expenditures can no longer be postponed. Only by committing now in a clear and credible way to a path of budgetary consolidation can governments preserve the flexibility they deem necessary in the short term. The other risk is that a protracted period of very low policy interest rates and abundant liquidity may end up fuelling new asset price bubbles, thus building up the conditions for the next crisis. There is growing concern that this may already be happening, although the evidence so far is mixed: – In advanced economies, markets for equities and other risky assets have staged a stunning recovery since March. As regards equities, there is not yet clear-cut evidence that this has gone too far, based on the indicators usually watched to See also, on this and other challenges ahead, I. Visco, “Challenges to international cooperation in the wake of the global crisis” (intervention at The Italian Chamber of Commerce and Industry in the UK XXXI Annual Conference on “A new approach to global economic and social growth”, London, 16 October 2009, available at http://www.bis.org/review/r091021e.pdf). On the reform of the international monetary system, I would also refer to the recent IMF paper, “The debate on the international monetary system”, by I. Mateos y Lago, R. Duttagupta and R. Goyal (SPN/09/26, November 2009). IMF, “The state of public finances. Cross-country fiscal monitor: November 2009” (SPN/09/25, November 2009). assess asset valuations. However, this depends crucially on how strong we expect the economic recovery to be, and there is still considerable uncertainty on that. An equally striking shift in attitudes toward risk seems to have occurred in corporate bond markets, where risk spreads have narrowed substantially even though default rates are continuing to rise. – In the case of prices of raw materials the evidence of overvaluation is, at the moment, rather scant. Yet, pressure on prices may rapidly grow – as it did in 2008 – once world demand returns to a more sustained pace of growth. – In my view, the risk of an excessive creation of liquidity feeding bubbles in financial and real asset prices is significantly greater in emerging economies, many of which have been receiving large capital inflows. Controlling the effects of such inflows on domestic credit and asset markets is especially difficult in those countries that, by choosing to peg their exchange rate, import the monetary policy stance from abroad even though it may not be appropriate to domestic conditions (Figure 6). This raises two difficult questions. The first is whether the timing and speed of monetary exit strategies should be contingent on developments in asset markets. If the latter were to signal that abundant liquidity is feeding new speculative excesses while the economic recovery is not yet firmly established, a trade-off could potentially arise between macroeconomic and financial stability. The second question is to what extent, if any, monetary policy in the United States should be conducted taking into account the fact that it is also exported to emerging economies with pegged exchange rates, such as China. In earlier times this question could have been easily dismissed, since the feedback effects of the induced monetary expansion abroad on the US economy and its financial system were second-order. Now, however, this is no longer the case, as witnessed by the key role played by global macroeconomic interactions in the genesis of the crisis, as I have outlined above. You will probably recognize that these are – in slightly different form – the same two issues that I put at the centre of my analysis of how macroeconomic policies helped create the conditions that led to the crisis. The fact that we are still grappling with them as we come out of the global recession suggests that they are largely unresolved. This shows how delicate and important is the continuation and effective enhancement of the international economic policy cooperation so forcefully advocated within the G20 process. Figure 1 Current account balances (in percent of world GDP) Projections -1 United States Euro area China Em. Asia excl. China Oil exporters -2 Japan Source : IMF, World Economic Outlook, October 2009. Figure 2 Cumulated current account balances (in percent of GDP) Projections Japan China Oil exporters (1), Em. Asia excl. China Euro area -10 United States -30 United States -50 -70 Sources : IMF, World Economic Outlook, October 2009; Bureau of Economic Analysis. Notes : (1) Calculated as the cumulated current account balances, starting in 1980. (2) Inludes only emerging and developing economies. (3) Actual net foreign asset position (at market values). Figure 3 Nominal Effective Exchange Rate (2005 = 100; monthly data) United States Euro area Japan China Source : Bank for International Settlements. Note : increases signal appreciation. Figure 4 Public sector fiscal balances (percent of GDP) Projections -2 -4 -6 -8 -10 Japan United Kingdom -12 United States Euro area -14 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Sources : IMF, World Economic Outlook, October 2009. Notes : (1) General government. (2) Based on WEO projections, which assume some fiscal tightening starting in 2010 in emerging economies and 2011 for advanced economies. Figure 5 Public debt levels (percent of GDP) Projections Japan United Kingdom United States Euro area 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Sources : IMF, World Economic Outlook, October 2009. Notes : (1) General government gross debt. (2) Based on WEO projections, which assume some fiscal tightening starting in 2010 in emerging economies and 2011 for advanced economies. Figure 6 Equity prices in US dollars (daily, January 2007=100) Jan-07 May-07 Sep-07 Emerging Economies Jan-08 May-08 Brazil Sep-08 China Jan-09 May-09 Sep-09 Russia India G7 Source : Thomson Reuters Datastream. | bank of italy | 2,009 | 12 |
Remarks by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the FSB ,for the European People's Party high-level policy debate, EEP Statutory Congress, Bonn, 9 December 2009. | Mario Draghi: The social market economy and the solutions to the global financial and economic crisis Remarks by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, for the European People’s Party high-level policy debate on "The social market economy and the solutions to the global financial and economic crisis", EPP Statutory Congress, Bonn, 9 December 2009. * * * I am very pleased to be here to talk about progress in finding and implementing solutions to the global financial crisis. You have decided to focus today and tomorrow on issues that are critically important to our economies and our citizens. And I am honoured to have this opportunity to speak about where we are in terms of financial regulatory reform, what has been achieved to date and the priorities ahead. One year after the climax of the financial crisis, market conditions have eased significantly and a degree of confidence in the financial system has returned. However, the market reaction to Dubai’s woes is a reminder that they remain unusually vulnerable to shocks. The crisis has implied a massive transfer of debt from the private to the public sector. Fiscal positions have deteriorated across the board at an unprecedented pace. Public deficits in the G7 countries have surged from 2% of GDP in 2007 to 10% today. The limits set by the Stability and Growth Pact will be exceeded until 2014 at least for the euro area. Although necessary and unavoidable, those extraordinary borrowing needs, combined with long-term fiscal challenges on healthcare, pension systems and climate change, will lead to public debt in excess of 100% of GDP in OECD countries in 2010 (up from 74% in 2007). It is no surprise therefore that markets have been recently more sensitive to accumulating debt burdens in government and quasi-government sectors. Sovereigns represent an increasing share of transactions in credit protection markets (CDS), as market participants challenge the assumption that they are risk-free. Government auctions have faced from time to time unsatisfactory demand, even for highly-rated issuers. Sovereign CDS premia remain volatile and elevated. Markets also show more discrimination across countries. While developed countries come under funding pressure, emerging countries with low debt levels are now able to issue long term, as shown by the recent 50-year bond of China, sometimes at fixed rate and in local currency, which was unimaginable just a few years ago. So there is a way out, but governments need to communicate credibly their medium-term plans to restore fiscal sustainability, in order to limit upward pressure on their funding costs and to retain their ready access to global markets. That is important not only to deliver fiscal prudence, but also to avoid adverse spill-over to the rest of the financial system given their pivotal benchmark status. On the funding front, there are also heightened risks of crowding out. Global refinancing needs are firmly skewed towards shorter term maturities. Estimates differ, but bank and corporate bond redemptions hover around USD 3 to 4,000 billon annually from 2010 to 2012, double the annual amount of the mid-2000s. Roll-over of government debt will come on top of those needs. Leveraged borrowers such as high-yield companies also face refinancing pressure. And securitization markets are thawing only very slowly. Overall, markets will need to refinance higher debt levels with lower average quality and with a reduced tolerance towards leverage, in a time window when support schemes will progressively unwind. Such absorption pressure may well lead to higher and more volatile funding costs. Therefore, it is now time that financial institutions and corporates engage proactively in lengthening their debt profile and tapping global markets in an orderly fashion given the risk that they may otherwise be forced to raise funds under less attractive terms. Amidst these challenges, restoring a well functioning market-based economy also requires exiting from the exceptional financial sector support measures introduced since 2007. Clearly, the timing, speed and modalities of exit involve important trade-offs, and judgment will need to be used. Implementing exit strategies will require striking an uneasy balance between exiting too early and too late. This underscores how important it is that we resolve the regulatory issues in front of us, which will be part and parcel of our ability to exit this crisis with confidence in the resilience of our financial system. Bolstering the resilience of the financial system is a broad project encompassing a considerable number of related measures. It involves multiple layers of policy authorities across countries and sectors. And it requires coordination and a joined-up international response, both for making our policies effective and for establishing a level playing field. Driving forward a coordinated global regulatory response has been the key role of the G20 Leaders and of the Financial Stability Board, which I have the honour to chair. Much policy development has been achieved – more than meets the eye – that when implemented, will result in a very different financial system than the one that brought us this crisis: a more resilient, disciplined, less procyclical and less leveraged system; one where the perverse incentives to excessive risk taking – with private gains and socialised losses – that characterised the recent past will have been removed. Substantial progress has been made on a very broad front, and we have now not only a consensus internationally on the objectives of the reform agenda, but a broad commitment to consistent implementation at the national levels. To name just a few of the significant changes that have already occurred: we have closed loopholes and corrected shortcomings in the bank capital and liquidity frameworks; we have addressed weaknesses in accounting standards; improved risk management and disclosure standards for financial institutions; introduced new standards and principles on sound compensation; and we have enhanced oversight of credit rating agencies and hedge funds. But we are far from done. Work is underway in critical areas, and implementation of the full set of needed reforms will require political will and perseverance. We simply must take the steps that are needed to ensure we can exit this crisis confident that we have put in place a much stronger system for the future. A lot of what needs to be done requires international consistency because finance is global. It is therefore of critical importance that, as we set out a constructive path for reform in our respective constituencies, we work to ensure that this takes place with a view to preserving the advantages of integrated global financial markets and a level playing field across countries and sectors. The Financial Stability Board takes this very seriously. Completing and implementing financial reform thus remains a key imperative – both nationally and internationally. Let me now speak to some of the areas where critical decisions in the months ahead will determine whether credible reform is achieved. I will leave aside the issues of reform of national and regional oversight structures, and focus on bank capital and liquidity, compensation, accounting, derivatives, and addressing the moral hazard posed by institutions that are too big to fail. • Improving bank capital is clearly the single most important project to build greater resilience into the system. Through the Basel Committee on Banking Supervision, we have now agreed the key measures needed to strengthen the capital framework – raising the quality and quantity of capital; introducing a leverage ratio that will constrain bank leverage; and requiring banks to create countercyclical buffers that can be drawn down during bad times. Proposals on the first two will be developed by the end of this year and on the last by the middle of next year. A comprehensive impact study and the calibration of the overall capital level will be undertaken by end-2010, looking at the cumulative effect of all the reforms and how they interact. In other words, there will be no simplistic layering of the different elements. The changes to Basel II will be substantial, and they will be phased in over an extended period so as avoid any adverse interaction with current conditions. • Regulation is being substantially enhanced on bank liquidity as well. The Basel Committee will issue for comment early next year a new minimum liquidity standard directed at ensuring global banks hold sufficient high-quality liquid assets to withstand a stressed funding scenario specified by supervisors. This too will be subject to an impact assessment. • On compensation, countries are taking actions to implement the FSB standards issued in Pittsburgh and others will be following shortly. These standards address the structure and governance of compensation; they also call on firms – on public policy and prudential grounds – to restrict compensation levels so long as this is needed to retain and build the necessary level of capital. This is an area in which it is absolutely essential that authorities take robust collective steps if they are to dispel expectations that business can go on as usual. The FSB is now launching a review of the actions taken by authorities and firms, focusing on consistency and effectiveness at achieving the intended results, and will propose additional measures as needed. • On accounting, we have seen progress in the revamping of financial instruments accounting. But we are quite some distance from achieving the objectives of improved, converged standards that are less complex and less prone to amplifying economic cycles. This is a difficult area that we are pursuing vigorously through dialogue between the accounting standards setters, prudential regulators and other stakeholders. But we must do so in way that respects the integrity and independence of the standards setting process. • Last but not least, we must reduce the moral hazard posed by institutions that are too large, or too complex, or too interconnected to fail. The large-scale support we provided in this crisis to stave off systemic collapse has materially worsened moral hazard risks. Why should our financial firms now believe that authorities will not stand behind them if conditions were to turn again to the worse? Moreover, many of our banks have become larger, not smaller as a result of crisis-related mergers. Moral hazard risks pose a large prospective burden for taxpayers and are a serious threat to the maintenance of a market-based system. So what is to be done? • At the Pittsburgh Summit, the G20 Leaders called on the FSB to propose by endOctober 2010 possible measures to reduce these problems. We are now evaluating approaches under three headings, while recognising that there will be no silver bullet or a one-size-fits all solution in this area: – First, reducing the probability and impact of failure of a systemically important institution. The aim is to link capital and liquidity charges more closely to the externality or spill-over costs of failure. Here, we will be investigating a capital surcharge for systemic importance, as well as what role new capital instruments, such as contingent capital, or other insurance schemes could play. We will also consider options to incentivise structures and business models that support effective supervision. – Second, improving resolution capacity, by establishing credible resolution frameworks for large interconnected financial institutions – frameworks that have the ability and funding to preserve the continuity of a failing institution’s core functions, and the authority to impose losses on shareholders and unsecured creditors Work is also underway to improve ex ante crisis preparedness and resolution, including through the use of “living wills”. We must recognise, at the same time, that achieving effective resolution of crossborder entities will ultimately require addressing very difficult issues – such as recognition and harmonisation of resolution regimes, and how to share across borders the costs of a resolution. – Third, strengthening the core financial infrastructures and markets to reduce contagion risks, including by moving over-the-counter derivatives onto exchanges or central clearing platforms. Action in this latter area can shrink the risk exposures arising from interconnectedness that contribute to authorities having no choice but to bail out systemically important financial institutions. Let me conclude with two general remarks. First, effective work to strengthen the global financial system requires policies that are well designed and will be robust over the long run. This necessarily takes time. It is important, therefore, that governments send a strong message that they are determined to see these reforms through. Where international policy development is ongoing, it needs continued support; where such policy work has concluded, we need commitment to consistent national implementation. Second, given the commitment G20 Leaders have made to coherent approaches as we improve financial regulation, we must strive to overcome inconsistencies in final rule-making and implementation at the national and regional level so as to achieve a level playing field. The FSB will monitor this by undertaking regular peer reviews among FSB members – both country-by-country, and by topic across the entire membership. The fundamental value of our peer reviews will be the dialogue and constructive engagement of our members towards the common objective of a well regulated, open, and market-based financial system. In a global context, it is of course critically important that standards are raised everywhere. In the FSB, we have embarked on a process to identify the non-co-operative jurisdictions that fail to implement internationally agreed standards in the prudential and regulatory area. We are developing a toolbox of measures that will incentivise adherence to reforms in these jurisdictions. We are working closely with the IMF in these areas, which has a key role in surveillance of the global financial system, and, together with the World Bank, are well-established assessors of authorities’ implementation of key financial sector policies and standards. We will also collaborate closely with the new European Systemic Risk Board and the European financial supervisory structures that have now been put in place. Our shared goal is a stronger and more resilient international financial system in which threats to stability are engaged earlier, are better cushioned when they materialise, and where protections are adequate to give our citizens and countries confidence in an open and integrated financial system. | bank of italy | 2,009 | 12 |
Remarks by Ms Anna Maria Tarantola, Deputy Director General of the Bank of Italy, at the 25th Anniversary of the Foundation of the Association of Foreign Banks in Italy, Milan, 20 November 2009. | Anna Maria Tarantola: Supervision of foreign banks in Italy Remarks by Ms Anna Maria Tarantola, Deputy Director General of the Bank of Italy, at the 25th Anniversary of the Foundation of the Association of Foreign Banks in Italy, Milan, 20 November 2009. * 1. * * Introduction I am happy to participate in this seminar marking the quarter century since the foundation of the Association of Foreign Banks in Italy. I witnessed the beginning of the association with the encouragement of Guido Rosa, Vittorio Foroni Lo Faro and Remigio Saracino, who were always ready to bring up the problems that foreign banks, mainly present with branches back then, encountered in Italy. These twentyfive intense years have seen a succession of phases of growth and recession, enormous changes in finance and the real economy, the opening up of national markets, the steady integration of the main financial systems and the introduction of the euro. The last two years have been particularly difficult, marked by a deep and far-reaching crisis that, in the financial sector, has made evident distorted incentives, opportunistic behaviour and widespread vulnerabilities which often had not been fully perceived. The crisis now seems to be loosening its grip. The main international institutions agree, on the basis of the latest cyclical indicators, that economic activity has stopped contracting; the improvement in the indicators of consumer and business confidence suggest the coming months will bring a recovery, though a slow one. The state of the financial system has also improved; the wholesale and retail markets, fundamental for the procurement of funds and the exchange of financial products, appear to be gradually getting back into gear. But we are far from the pre-crisis levels of output and employment. In many countries, including Italy, the magnitude of the crisis and its effects on the real economy are such that years of rapid growth will be needed to return to those levels. The weak international recovery we are seeing is mainly driven by the support measures put in place by the governments of the main countries. The expansion is proceeding at a faster pace in the emerging countries, in particular those of Asia, which have shown a greater capacity to resist and react – perhaps in part because of the lessons learned in the crisis at the end of the last millennium. Hopefully, careful and consistent economic policies will enable this wave of recovery to extend fully to the advanced economies and Italy. In the financial field, the major items on the agenda are two: to swiftly put into place a new regulatory and supervisory framework that remedies the deficiencies brought out by the crisis, and to make the financial system fully operational again so as to ensure, in Italy as elsewhere, the flow of resources needed to accompany and sustain the economic recovery. The process of stabilizing and strengthening the financial system and rewriting the rules is proceeding according to the calendar set by the leaders of the G20 and the Financial Stability Board (FSB). The set of reforms, once enacted, should increase the financial system’s resilience to shocks, encourage the development of models for intermediation oriented to long-term results, and eliminate the incentives for excessive risk-taking by stimulating more far-sighted behaviour based on the sound and prudent management of intermediaries. Concerns that the banking system will be unable to provide sufficient support to the economy are particularly strong in Italy, not least because of the financial structure of our small and medium-sized enterprises, heavily dependent on bank credit and historically skewed towards short-term debt. The crisis can – and must – be an opportunity for resolute action to rebalance the structure of firms’ liabilities. In their selection activity, banks must be able to assess firms’ long-term growth potential, to assist them in their development. In this context, the contribution of foreign banks can be significant, especially in some segments of the economy. In Italy today, the branches and subsidiaries of foreign intermediaries account for one fifth of all bank intermediation, a share comparable to that of many other advanced economies. An analysis of the past is useful not only to identify the contribution that foreign banks have made to their host markets – in terms of competitiveness, innovation and the quality and quantity of services provided – but also to outline their possible future contribution. This has several determinants: the types of foreign intermediaries, their business model, their objectives, their results and the impact on prices. The Bank of Italy is following these matters closely; indeed, it could not do otherwise. I will therefore retrace some of the stages of the success story of foreign banks’ expanding role in Italy and highlight the difficulties that must be overcome so that this progress may continue to the benefit of the Italian economy, and the implications for the Bank of Italy. 2. Internationalization There are several reasons why a bank may decide to enter foreign markets: i) to take advantage of the host country’s growth potential and thereby tap new profit opportunities; ii) to follow its own customers abroad; and iii) to diversify its activity. A recent survey by the European Central Bank of the drivers of the international expansion of the largest European banking groups highlighted two main factors. Some 80 per cent of the respondents declared that expansion abroad was aimed at exploiting growth opportunities in the host market and thereby increasing profit margins, while 59 per cent cited the need to provide services to their customers operating abroad; 1 business diversification was a less important goal. In the past decade the integration of international financial systems has intensified and extended to the banking system. In many countries the number and the market share of foreign intermediaries have grown as a result of the expansion of banking groups’ activities beyond national borders and the increase in cross-border mergers and acquisitions. The process, initially involving the financial markets of the emerging countries, has spread to the mature economies, albeit to a more limited extent. 2 In the European Union, cross-border bank mergers and acquisitions have increased in both number and value. Between 2005 and 2007 more than 350 were carried out, largely between intermediaries from different countries. The trend abated in 2008, owing to the international financial crisis, but it did not come to a halt, with cross-border mergers and acquisitions down in number but up in value from the previous year. 3 At the end of 2007 branches and subsidiaries of foreign banks accounted for a little less than 30 per cent of total bank assets in the European Union. Foreign banks have a particularly large market share in the United Kingdom, where it exceeds 50 per cent thanks above all to London’s central role in international finance. It is also large in the European Union’s new member countries, in connection with the acquisition of major local banks by foreign intermediaries. In the euro-area countries, foreign banks’ share of total assets averages about 20 per cent. The share of loans granted by non-domestic institutions has doubled in European Central Bank, EU Banking Structures, 2008. Committee on the Global Financial System, Foreign direct investment in the financial sector of emerging market economies, Bank for International Settlements, 2004. European Central Bank, Financial Integration in Europe, 2009. the last ten years, rising from just under 4 to about 8 per cent of outstanding loans to EU residents (from 26 to 37 per cent for bank and financial counterparties). Foreign banks are major players in the economies of central and eastern Europe, where they contributed to the privatization of the banking system after the collapse of communism. In those countries the leading international banks raised the efficiency of the financial system with transfers of know-how and technology, improved the allocation of credit and brought stability after the severe financial crises of the early 1990s. However, the recent financial crisis has revealed the risks deriving from the excessive concentration of the credit markets and their vulnerability to events originating in the foreign banks’ home countries. In the mature economies of Europe, the nature of the benefits and risks generated by the integration of banking systems is similar but their scale is smaller. Within the European Union we have seen a reduction in interest rate differentials and convergence towards the most competitive levels. 3. Foreign banks in Italy I said that foreign banks are spurred to enter a country by the growth prospects of specific market segments in which the host-country’s intermediaries do not enjoy locational advantages or are lagging in adapting their supply. Our own history provides more than one example of this. The number of foreign intermediaries in Italy has risen continually in the last twenty-five years, from just over thirty in the mid-1980s to more than one hundred today. Their market share is significant. In 2007, the latest year for which we have data for an international comparison, their share of total bank assets was 17.4 per cent, higher than the corresponding figures in Germany, France and Spain (11.1, 12.9 and 11.6 per cent, respectively). It declined slightly in the first half of this year, to 16 per cent, owing to the international financial crisis and the exit of some intermediaries from the Italian market. Foreign banks’ reasons for entering Italy have changed over the years. A first substantial inflow dates from the late 1970s and early 1980s, in parallel with the growth in world trade and the business expansion of multinational corporations. Many foreign banks began to operate in Italy through branches, mainly in order to serve prime customers on the spot. Another factor of no small importance was their objective of taking advantage of the administrative constraints then burdening the operations of Italian banks. In particular, foreign intermediaries could exploit their parent banks’ foreign currency funding, which they used to make foreign currency loans to both non-bank customers and Italian banks, and the possibility of raising funds at moderate costs on the interbank market. Foreign banks accounted for about 4 per cent of total assets, with a higher market share for loans to non-bank customers and for commitments and contingent liabilities. The profit margins they achieved on both loans and investments were substantial, especially compared with those obtaining in their home countries. In this first phase, marked by strong regulatory constraints on the activity of Italian banks, foreign intermediaries helped decisively to expand the range of services, especially financial services, offered to customers. On the other hand, their scant presence in retail banking markets limited their contribution to the growth in competition. Starting in the mid-1980s the Italian banking system underwent progressive liberalization and modernization whose milestones were the removal of the ceiling on the growth in bank lending, the abolition of the securities investment requirement and the lifting of the restrictions on branching. All this affected the activity of the foreign banks, which contracted – significantly in several instances – in some business segments. By 1990 their share of total assets had fallen to 2.6 per cent and that of loans to non-bank customers to 3 per cent. In response to these developments, foreign intermediaries moved increasingly into wholesale financial markets, which were relatively backward at the time but with good potential for growth: they quickly expanded their presence in securities business, asset management services, correspondent banking (cash management for customers, as well as hedging and foreign exchange transactions) and investment banking (in particular raising funds directly on the capital market by placing equity and bond issues and syndicated loans). In the mid-1990s, the foreign banks’ off-balance-sheet transactions exceeded 42 per cent of the system’s total, mainly owing to the large volume of forward business in securities and derivatives. Throughout this phase, the most popular type of establishment was still the branch, which was more flexible and better suited to supply policies centred on specific ranges of services geared to a limited time horizon. When, in the 1990s, the European regulatory framework was completed with the institution of freedom of establishment and home country control, a level playing field was created for the activity of local banks and foreign banks and competition intensified further. The creation of a single banking market in Europe drastically altered entry procedures for EC banks, which now had a quicker method of access – simple notification to the Bank of Italy – that obviated the need for endowment funds for their branches. Supervision of the foreign establishments of EU banks was entrusted to the home country authorities, except in respect of liquidity. The process of integration accelerated with the introduction of the single currency, which acted as a catalyst for the main corporate projects of industrial and financial reorganization. Partly as a result of these developments, foreign institutions have entered the Italian market in greater numbers in recent years, and increasingly in traditional banking business, seeking to exploit not only the growth potential of the retail and mid-corporate sectors but also Italian households’ considerable saving capacity. Entry into the retail market was achieved mainly by takeovers of local banks and financial companies, not least to gain the competitive advantage stemming from local roots and close customer relations. Subsidiaries of foreign banks operate as networks of their international groups they belong to; their commercial policies are geared to expansion, to enlarging the network and strengthening links with the product companies of the foreign parents. Between 1990 and 2005, the market share of foreign intermediaries rose from 2.6 to 8 per cent of total assets. It has expanded further since then, to around 16 per cent in the first half of 2009. There has been a substantial increase in foreign intermediaries’ lending to households (Table 2). Operators specializing in mortgage lending and consumer credit using credit scoring techniques have entered the Italian market. This development, which facilitated households’ access to these forms of finance, also led to innovations in the types of contracts, 4 longer durations, higher loan ceilings, and a larger percentage of financial risk than the Italian average. In the first half of this year, 15 per cent of the mortgage lending market and 28 per cent of the personal finance market were accounted for by foreign banks, compared with 0.2 and 7.7 per cent in 1990. Their customer deposits have also increased, albeit more slowly than lending, rising from 1 per cent of the total in 1990 to over 9 per cent in 2008. Currently, foreign banks are present in Italy in a wide variety of formats (branches, subsidiaries, significant shareholdings); they occupy a leading role for a broad selection of Casolaro, L., L. Gambacorta, and L. Guiso (2005), “Regulation, formal and informal enforcement and the development of the household loan market. Lesson from Italy”, Bank of Italy Working papers (Temi di discussione) no. 560, September. products ranging from corporate banking services to wholesale market operations and clearing and settlement services, from project finance to asset management and financial advice, and from leasing to traditional banking. In certain segments, such as depositary bank services, local government financing and consulting, and the structuring and sale of derivative instruments, foreign banks play a major role. Their branches and subsidiaries account for almost a quarter of the total securities held for custody, a share that may increase significantly if and when the sales announced by several large Italian groups go through. It is important that the advantages of the possible economies of scale be passed onto customers and that the services provided be effectively adapted to the needs of Italian operators. The Italian branches of foreign banks have seen their profits suffer as a result of the crisis since their business tends to be concentrated in the investment banking sector, which has borne the brunt of the downturn. Their earnings have become negative. Subsidiaries, on the other hand, have had generally positive results. All of them were profitable in 2008 and in some cases their gross income and gross operating profit increased. These results are particularly important when compared with those of the foreign parent companies, many of which sustained heavy losses and a substantial rise in allocations to provisions. The reason for the better performance of Italian subsidiaries is their focus on retail banking. Cost-cutting measures, including downsizing, also contributed. The differences between the types of business of branches and subsidiaries are reflected in the recent performance of lending by the two categories. In the case of branches, for a long period, and until the summer of 2008, the rate of growth in lending was over 20 per cent, owing to the sharp expansion of syndicated loans to medium-large firms and financial companies; it then progressively contracted, to turn negative by 5.6 per cent in September 2009, as a result of the impact of the crisis on wholesale operations. By contrast, subsidiaries continued to record higher rates of growth than the system average, for lending to both households and firms. Empirical analyses by the Bank of Italy 5 indicate that foreign banks have helped to increase customer mobility, particularly in the case of households, and encouraged product innovation. The increased competition led to a drop in interest rates on medium and long-term mortgage loans to households. The annual reduction averaged about 15 basis points over the period 1997–2006 and 18 basis points in the last five years. More recently, the average collateral on medium and long-term loans has also decreased, presumably as a result of rising loan-tovalue ratios. The entry of foreign banks does not appear, however, to have affected the interest rates applied to firms, either on short or on medium-to-long-term financing. This is probably due to the difficulty foreign banks have in evaluating projects to be financed because of their lack of local roots and hence of a close relationship with borrowers. Even in the case of firms, however, the presence of foreign banks has been accompanied recently by a tendency to reduce the collateral on medium and long-term loans. Infante L. and P. Rossi (2009), “The Retail Activity of Foreign Banks in Italy: Effects on Credit Supply to Households and Firms”, Bank of Italy Working papers (Temi di discussione) no. 714, June. 4. Supervision The changes in the presence of foreign banks operating in Italy and in their business models have led to major alterations in the approach taken by supervision. These developments have been strongly influenced by the progress of international financial integration, above all in Europe. In the single European market the principle of home-country control means that branches of banks from other member states are subject to a significantly different supervisory model from that applied to subsidiaries established under Italian law. Controls on the former are entrusted almost entirely to the home-country authorities, with the notable exception of liquidity risk, which is monitored by the host country. The Bank of Italy monitors liquidity risk in various ways; since September 2008 controls have been tightened and banks are now required to maintain a positive net liquidity position on maturities up to one month. When the strains were at their height, direct steps were taken in respect of foreign parent banks, with the help of the relevant supervisory authorities. Specific measures of an extraordinary nature can be adopted for branches of foreign banks with a significant volume of deposits raised in Italy. The Bank of Italy’s supervision of branches includes important controls on the transparency of banking services offered to customers and against money-laundering, about which I will say more shortly. Controls on subsidiaries are more intensive and resemble those applied to Italian banks. In keeping with the new prudential framework established in the Basel II Accord these must be coordinated between the home- and host-country authorities. This highly ramified supervisory system involving various authorities with different powers makes the task of supervision a complex and difficult one, in a setting in which foreign intermediaries are exposed to an expanding array of risks, including operational and reputational risks. As in its supervision of Italian banks, the Bank of Italy increasingly directs and calibrates its activity based on risks and their importance. To comprehend their evolution and impact, it has held more meetings with the subsidiaries of foreign groups. This dialogue is useful for a timely and in-depth analysis of operational choices, in the context of those taken at group level, and of the risk management and control systems. Inspections, including those of a partial nature, have been intensified. A start has been made on action to strengthen internal control systems, which were found to be inadequate in some cases. The reaction has been positive, but the process of adapting to higher standards is not yet complete. The corporate culture of several big financial groups requires a thorough rethinking in order to forge a new relationship between business units and control functions. These controls must be assigned greater importance than in the past. The performance of depositary banks’ activities require organizational structures and working processes capable of curtailing the operational and reputational risks to which custodians are subject. The regulatory framework governing this sector in Italy fosters reliable and transparent conduct: for example, the distinction between management companies and depositary banks makes it easier to control their operations, the quality of valuations and the actual amount of assets held for custody. This arrangement has prevented the emergence of similar risks to those seen in other systems. Efforts must continue to make this activity even more effective and secure for customers. Derivatives business can expose banks to major legal and reputational risks, as the numerous ongoing legal disputes testify. For some time now we have intensified our activity on this front, both by reminding banks of the need for proper conduct and careful risk assessment, and through the monitoring of the phenomenon, including via targeted on-site controls. We must not lower our guard. One aspect that can condition supervisory activity is the availability of full information on the activity of foreign branches, and to some extent also of the subsidiaries present in Italy, when their role is merely to distribute products developed abroad, often in London. In these cases it becomes difficult to obtain, even during on-site examinations, the documentation needed to reconstruct the operations of the foreign intermediary in Italy; in some cases the transactions in question are complex, exposing banks to high operational, legal and reputational risks that are difficult to quantify. In accordance with the division of responsibilities under Community legislation, there is a need for greater cooperation between foreign intermediaries and the authorities of the countries in which they offer their services. Improvements in transparency are necessary: foreign intermediaries must also comply with the advertising obligations, follow the rules on contracts and, in general, set up customer relations on a completely correct basis. It is essential, in particular, that a careful selection be made of agents responsible for distributing credit cards, a sector in which several foreign banks are very active. A qualitative leap is also called for on the sensitive issue of money laundering, with a greater commitment by top management, more intensive staff training and more stringent controls. At times we have found the phenomenon to be underestimated by foreign parent banks when setting up programmes for organizing and reorganizing their Italian units. The supervision of foreign banks must reconcile the requirements of control over institutions that can have systemic importance in the national territory with the powers of the supervisory authority in the country where the parent company is established. This is a delicate process, requiring a balanced and pragmatic approach. The Bank of Italy has stepped up the activity it performs in the colleges of supervisors. In addition to validating internal risk-measurement systems, the colleges’ activities have gradually – and not without difficulty – been extended to broader issues, concerned with the very stability of cross-border banking groups. 5. Developments in regulation and supervision The integration of the markets and the broad process of internationalization can facilitate the spread of instability, even if localized at first, and require a coordinated response. This is why it is essential not only to proceed rapidly to introduce new common rules for the financial sector, aimed at reducing the risk of systemic crises, but also to achieve greater homogeneity in their actual application and to strengthen cooperation between national supervisory authorities. The proposals for reform of the rules touch on numerous issues: the capital adequacy of banks, the size of the regulatory perimeter, the planning of measures to attenuate the pro-cyclicality of banking activity, capital buffers, the introduction of limits on the financial leverage of intermediaries, the improvement of corporate governance and executive compensation mechanisms, the role of systemically important intermediaries, integration between macro-prudential and micro-prudential supervision, and international coordination between authorities in supervising cross-border institutions. Effective supervision of international groups and the institution of a truly integrated monitoring process will require overcoming the divergences still found between the approaches of the various authorities, especially in the definition of the scope of consolidation for banking groups, the application of Basel Pillar 2, the treatment of liquidity risk, the reporting of off-balance-sheet vehicles, accounting standards and prudential reporting. The FSB, under the leadership of the Governor of the Bank of Italy, has concluded that the international college of supervisors is the most suitable instrument for strengthening cooperation and information exchange among the national supervisory authorities involved in the oversight of cross-border groups. This instrument, already current within the European Union and amply utilized in Italy, will be reinforced in the near future and extended to all cross-border groups. To make action more effective, a clear legislative framework and a precise definition of the powers and duties of colleges are necessary. For the most part, they have worked well as the place for information exchange but have not developed a real capability for the joint assessment of the risks of groups and their components or for the effective coordination of supervisory action. Colleges’ decision-making powers need to be reinforced, with machinery for settling disputes and a powerful coordinating role for the consolidated supervisor. This process should be complemented by greater recognition of the role of the parent company under Community legislation on banking groups to establish a proper distribution of costs and benefits among all the components of the group. The Italian law on banking groups can offer useful points of reference here. In addition, colleges need to become the forum for the integrated risk assessment of groups and their main components, in order to plan supervisory action and corrective intervention. This requires the development of common methodologies and the sharing of information, including through central databases accessible to all the authorities within the college, to favour joint monitoring of the main risks. There have been problems in the management of crises involving cross-border groups. In particular, what is lacking is agreement on the method for sharing the costs of intervention. In practice, government support has gone exclusively to the national members of troubled groups and not to sustain the group as a whole. Supervisory colleges have not played a central role when group crises have occurred, as would have been desirable. Even in cases in which cooperation was thought to have produced a good degree of uniformity in regulatory approaches, national needs and practices prevailed. The “too-big-to-fail” syndrome is currently under discussion in international fora, with various proposed remedies, including the imposition of additional capital requirements and other, more radical proposals for reducing the size and interdependence of group structures with global systemic relevance. The debate is still just beginning, and the eventual results could have a considerable impact on market integration. The European Commission has worked up a set of proposals to improve cooperation among national supervisors, harmonize crisis management and resolution measures and clarify the standards for sharing the costs of banking crises among countries. The most significant proposals are for: enhancing the quality and quantity of information that home and host supervisors exchange, both in normal times and in crises; host supervisors’ participation in colleges, including when the case involves important branches or subsidiaries; creating a new European System of Financial Supervisors (ESFS) grouping three sectoral agencies (the European Banking Authority, the European Insurance and Occupational Pensions Authority and the European Securities Markets Authority), for more effective supervision over the major European groups; and forming a new European Systemic Risk Board, in order to sharpen the macro-prudential focus of supervisory policy. A few weeks ago the Commission released a consultation document setting out its projects for enhancing supervisory authorities’ early intervention at ailing banks, and their crisis management and resolution. The idea is to revise European company and bankruptcy law, together with compulsory deposit insurance schemes, and, more generally, the financing of crisis intervention measures. The set of regulatory changes under consideration, once implemented, will have significant impact on the conduct of banking supervision over national and foreign intermediaries alike and on the roles and responsibilities of the various authorities. There will be a period of intense dialogue with intermediaries, whose organizational and business models could be affected. 6. Conclusion I believe that the Italian experience over the past twenty-five years has been positive on the whole. Foreign banks have significantly enlarged their presence in Italy and helped spread new business models, different even from those of their own home markets. These foreign intermediaries contributed substantially to the growth of the Italian banking industry in terms of innovation, service quality and quantity, and stiffer competition. Italian savers and investors benefited. The contribution was greater in some market segments, less noticeable in others. During the recent crisis, in Italy – unlike other countries – the presence of foreign banks did not cause strains or inflict losses on Italian savers and investors. However, more highly diversified lines of business and the rapidly evolving external environment have increased risk exposure, especially in some segments. The Bank of Italy has accordingly adjusted supervisory approaches and instruments to guarantee the continued effectiveness of its action, adapted to the evolution of risks. In recent years the chief focus has been on liquidity, operational, legal and reputational risks. The closer integration of financial markets heightens the danger of contagion. The debate on the effectiveness of supervision over the major cross-border groups, with their often overcomplex organization, is still under way. Obviously, this is a question that ranges beyond national confines. If the crisis was – unquestionably – global, then the review and reinforcement of the supervisory architecture needs to be as internationally coordinated as possible. The regulatory response to cure a financial system that has proven to be borderless and highly interconnected cannot be marked by divergent national emphases and approaches. It must follow common guidelines and methods of application based on shared principles. Otherwise, we would be leaving ourselves open to regulatory arbitrage and opportunism on the part of the large global players. In this new framework there cannot and must not be any room for supervisors to favour their own financial marketplace by light regulation. There is now broad international consensus on the need for common rules, uniform supervisory measures, severe and cogent enforcement, enhancement of the role of supervisory colleges and cooperation among authorities. Hopefully, this consensus will translate rapidly into practical action. The Bank of Italy is convinced that stepped-up cooperation and collaboration is the best way to minimize the risk of new crises and avoid the recurrence of the severe damage sustained in the last two years. As the authority responsible for prudential supervision in Italy, we scrupulously apply the rules agreed on internationally and in Europe, in tandem with especially careful and severe controls. This we do every day. Recent experience has shown that it is necessary to maintain this course. Annex (Tables and Figures) Table 1 Presence of foreign banks in the EU countries (with reference to the end of 2007) Number of foreign intermediaries present (branches and subsidiaries) of which: branches Belgium Market share of foreign intermediaries (total assets ) of which: branches 24.8 6.9 Bulgaria 81.6 4.0 Czech Republic 91.5 8.9 Denmark 19.3 5.0 Germany 11.1 2.1 Estonia 98.8 11.2 Ireland 46.7 10.2 Greece 23.2 9.6 Spain 11.6 7.8 France 12.9 2.2 Italy 17.4 9.5 Cyprus 32.1 11.8 Latvia 58.0 0.0 Lithuania 83.7 8.0 95.0 15.9 1.6 Luxembourg Hungary 57.4 Malta 42.6 0.0 Netherlands 17.6 2.5 Austria 26.9 1.2 Poland 70.5 4.1 Portugal 23.0 6.8 Romania 82.1 4.8 Slovenia 28.5 0.6 Slovakia 95.9 19.6 Finland 65.3 5.3 Sweden 9.3 9.0 United Kingdom 53.4 42.3 MU – 13 19.5 4.9 EU – 27 28.7 14.2 Source: Based on European Central Bank data. Table 2 Market shares of foreign banks in Italy (annual averages with reference to bank branches and subsidiaries) 2009 Total branches and subsidiaries Total assets 4.2 2.6 5.2 7.1 7.9 16.4 16.2 Interbank assets 9.8 6.0 15.7 12.9 13.3 20.6 17.1 Loans 5.2 3.0 2.7 5.8 9.0 16.2 15.8 mortgage loans 0.7 0.2 0.3 5.7 5.8 12.5 15.2 personal loans 11.5 7.7 6.2 14.2 27.7 35.4 27.5 Securities 1.6 1.5 6.3 10.1 9.9 17.6 12.0 Deposits 1.0 0.9 2.0 2.9 4.7 11.2 9.3 Interbank liabilities 13.7 9.7 16.3 19.3 24.0 32.7 27.6 Off-balance-sheet items Commitments and contingent liabilities 8.6 6.1 5.4 10.6 11.3 13.5 12.3 29.5 1.9 24.4 2.2 42.6 5.6 16.8 9.0 6.9 10.7 27.3 28.7 11.9 33.3 Securities held for custody of which: branches Total assets 3.3 1.8 4.1 4.8 5.4 9.4 8.9 Interbank assets 8.6 5.0 14.2 9.9 10.3 12.5 10.7 Loans 4.0 1.9 2.0 3.0 6.3 7.7 7.2 mortgage loans 0.2 0.1 0.2 0.7 2.6 3.6 4.6 personal loans 0.1 0.0 0.2 3.0 9.0 3.5 5.6 Securities 1.2 1.3 5.2 7.9 4.3 7.6 5.9 Deposits 0.2 0.2 0.8 1.4 3.2 3.0 2.2 Interbank liabilities 12.5 8.7 15.0 15.0 20.3 22.1 19.3 Off-balance-sheet items Commitments and contingent liabilities 6.9 4.9 4.4 6.2 5.2 5.5 5.1 28.6 1.3 23.0 1.5 40.9 4.5 15.3 7.2 4.6 8.5 20.0 14.5 7.8 10.8 Securities held for custody Source: Supervisory reports. (1) Average of the first 6 months of the year. Some items may have different definitions from the past owing to changes in the reporting procedures. Figure 1 Number of foreign banks present in Italy (with reference to bank branches and subsidiaries) changes over the year total foreign banks of which: branches -10 Source: Supervisory reports. Figure 2 Loans by EU banks to non-residents (amount by residence of counterparty as a percentage of total outstanding loans) other euro-area countries remainder of the European Union Se pt .-9 M ar ch -9 Se pt .-9 M ar ch -9 Se pt .-9 M ar ch -0 Se pt .-0 M ar ch -0 Se pt .-0 M ar ch -0 Se pt .-0 M ar ch -0 Se pt .-0 M ar ch -0 Se pt .-0 M ar ch -0 Se pt .-0 M ar ch -0 Se pt .-0 M ar ch -0 Se pt .-0 M ar ch -0 Se pt .-0 Source: European Central Bank. (1) Outstanding loans granted by banks having their registered office in the European Union to non-institutional customers resident in other EU countries. The counterparties do not include monetary financial institutions. | bank of italy | 2,009 | 12 |
Speech by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the 16th Associazione Italiana Analisti Finanziari AIAF - ASSIOM - ATIC FOREX Congress, Naples, 13 February 2010. | Mario Draghi: The world economic recovery and Italy’s part in it Speech by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the 16th Associazione Italiana Analisti Finanziari (AIAF) – Associazione Italiana Operatori Mercati dei Capitali (ASSIOM) – ATIC FOREX Congress, Naples, 13 February 2010. * * * The recovery The strains in the international financial markets have eased considerably in the last twelve months: the banks are once again raising funds and, in several cases, they have made significant increases to their capital; asset writedowns have diminished. Nevertheless, in the last few weeks the markets have become more volatile. The world economic recovery is under way, although in a different manner in different areas. The international organizations and private analysts are forecasting that this year China, India and Brazil will return to their high pre-crisis growth rates; not the advanced economies, whose growth is expected to remain modest, even in comparison with the initial upturns in previous recessions. The prices of oil and other raw materials have risen again. Despite this, inflation is still being held down by ample unused production capacity; in the next few months inflation in the euro area is expected to reach levels only slightly higher than in January, and it is likely to remain moderate in the medium term. The return to growth is still fragile, particularly in the euro area. Employment is slow to recover. Credit conditions for small and medium-sized enterprises are still tight and hindering recovery. Last year in Italy GDP fell by almost 5 per cent. Recovery is expected to be slow, with great uncertainty linked in particular to trends in the international business cycle and to labour market conditions. For many Italian companies, preexisting structural problems have been aggravated; others are able to take advantage of the crisis-induced changes in the market to increase their competitive edge. Domestic demand is still weak. At the end of last year, the number of people employed in Italy was down more than 600,000 from the peak of July 2008. The share of the potential labour force that is currently experiencing enforced idleness is large and growing. Until the fall in employment ceases, there remains the risk of repercussions on consumption and hence on GDP. Policies During the crisis, extremely far-reaching economic policy measures were essential in many countries: the central banks cut their interest rates to unprecedentedly low levels and resorted to unconventional expansionary measures; governments used their budgets to support the financial system and sustain demand and employment. These measures will have to be gradually phased out. As we emphasized at the last meeting of the Governing Council of the European Central Bank, the current level of official interest rates in the area is appropriate; no medium-term risk of inflation has emerged. The Eurosystem’s operations to support liquidity and banks’ lending capacity are continuing. Nevertheless, the unconventional measures that are no longer necessary thanks to improved financial market conditions are being gradually discontinued. In December, we announced that the main refinancing operations with twelve and six-month maturities would not be repeated beyond December and March, respectively. The exit from the current set of unconventional monetary policy measures should not be premature so as not to hinder recovery, but neither should it be tardy so as not to put price stability at risk and so as to avoid fuelling market distortions and speculative bubbles that would constitute the premises for new crises. At the beginning of March, we will take further decisions on the phasing out of the extraordinary operations, considering the prospects for price stability. The demand on the part of banks which may have difficulties raising funds can be satisfied without affecting monetary policy. As of now, it would appear necessary to normalize budget policies, at least by drawing up clear exit paths. The International Monetary Fund estimates that since 2007 in the leading advanced economies there has been a five-fold increase in the deficit, from 2 to 10 per cent of GDP. It also forecasts that budget deficits in the euro area will still be more than 3 per cent of GDP in 2014. In recent weeks, the state of the public finances in Greece has alarmed the international financial markets. If the Greek government adjusts its budget with determination, with careful monitoring by the European Commission and the ECB, the markets will subscribe new securities as old issues fall due, as happened in Italy at the beginning of the 1990s. It is nevertheless important that the euro-area countries have expressed their intention, should it prove necessary, to take decisive and coordinated action to ensure financial stability within the area. The public finances in many countries will be increasingly burdened in the coming years by costs associated with population ageing and climate change. A prompt and credible indication of the ways to correct the trend of the public debt is needed, among other things to reduce volatility in the financial markets and the issue costs of government securities. Increases in long-term interest rates would impact on the real economy, with possible repercussions on banks’ balance sheets, casting doubt on the strengthening of the financial system. Rules and controls on finance The purpose of the package of regulatory proposals recently announced by the Basel Committee on Banking Supervision is to strengthen banks’ stability and contain liquidity risk. Banks’ capital bases will have to consist of high-quality instruments, genuinely capable of absorbing losses; leverage will be curtailed; the procyclical aspects of regulation will be attenuated through the build-up of capital buffers and provisioning in periods of strong growth for use when losses materialize. In the early part of this year, the Committee will conduct a detailed impact assessment, in order to appraise alternative proposals, calibrate the new rules and set the new, higher capital requirements for banks. It will be important to verify the overall consistency of the framework, imposing stricter prudential requirements on those banks that operated with the particularly risky business models that were at the root of the crisis. The G20 leaders decided that the new rules do not have to take effect immediately, but only at the end of 2012, and in any event under the proviso that they not impair the stability of the markets and the resumption of an adequate flow of funds to the economy. They called on the Financial Stability Board to examine the macroeconomic implications of the reform, and to ensure the requisite gradualness of its implementation, with appropriate transitional and grandfathering clauses governing the instruments already issued. The crisis demonstrated the devastating repercussions of the failures of major financial institutions. Governments and central banks intervened to mitigate its impact; in so doing, at times they supported and protected the very institutions that had triggered the crisis in the first place. Moral hazard was compounded by the crisis: financial institutions have felt sheltered from the risk of failure and the fear this inspires, they have been taking new risks and, thanks to the extraordinary market conditions that have been created, are reaping enormous profits. Reducing moral hazard is a shared objective. This is to be done by lessening the likelihood of failures and circumscribing the attendant damage; creating mechanisms for their orderly management; and centralizing the channels that transmit their effects, such as derivative instruments, which nowadays are traded outside regulated markets and bilaterally. Criteria must be devised to determine the systemic importance of an institution. This will have to be done without compiling lists of intermediaries, which would create an unjust segmentation of the banking system and could have adverse effects on risk-taking. The following measures are being considered: more stringent capital and liquidity requirements, which will have to take account of the proposals already set out by the Basel Committee; the intensification of supervision; and robust and harmonized crisis management procedures. Other proposals aim to reduce the complexity of cross-border groups. One, in particular, would make it obligatory to operate in each foreign jurisdiction via a subsidiary, i.e. a company enjoying substantial autonomy in its funding, liquidity and operations. The segmentation of computer systems and procedures within a group may impede consolidated supervision; the groups’ international integration and the overall development of financial markets could be adversely affected. In any event, it is important that banks’ organization be simple, so that supervisory authorities can make a full assessment of the systemic risks in the event of a failure; in addition, it is more likely that we will move towards the subsidiary model if it proves impossible to attain minimum harmonization of the procedures for the resolution and winding up of major banks. The Financial Stability Board, which will present a report to the G20 summit in November, also envisages that banks will draw up emergency plans for refinancing, curbing risks, and in cases of evident insolvency, liquidating their assets in the most orderly fashion possible. Also under discussion is the desirability of separating traditional banking business from investment banking, with a view to limiting risk-taking by banks. As can be seen, there are various measures being discussed to address systemic risk, but they are all part of the process of international cooperation. Indeed, many are similar to those set out in the Basel Committee’s plan, where the higher risk of investment banking compared with traditional banking is dealt with through higher capital requirements. In this area it is unlikely, however, that countries with different banking structures, each affected by the crisis in its own way, will adopt the same measures; international cooperation will probably achieve minimum harmonization, while the capital and liquidity regulations provided for by the Basel reform aim at achieving maximum harmonization. In the new design of the structures of European supervision, the Commission’s project aims at harmonizing national authorities’ crisis powers and instruments through the introduction of special provisions for cross-border groups. We believe that Italy has complete and effective legislation in this field, together with valid practices and experience, all of which will need to be turned to account in the negotiations with the Community institutions. Europe has shown that it wants to increase the stability of the financial system while preserving a high degree of integration of the markets in the area. The analyses of the different authorities will need to be supplemented to arrive at truly uniform risk evaluations in the supervisory colleges of banking groups. Within the colleges for which we are responsible, we have vigorously promoted this integration. The objective of reconstructing a world financial system with more capital, less debt and the ability to withstand the collapse of large financial institutions without public aid is now unanimously shared. Agreement on a gradual transition towards this objective is also close. It is important that the international banking community participate in this process and fully appreciate the determination with which it is being pursued. That the new rules threaten the recovery by causing a contraction in credit is a claim that is easily refuted: the new system will be introduced gradually, and credit stopped expanding some time ago without the new rules even being known. Moreover, to believe that regulatory arbitrage will make it possible to elude the new rules underestimates the broad consensus on their introduction. It is possible that the combination of the various measures under discussion will result in a fall in banks’ profits, but it will also reduce the risks they run. It will be advisable to respond to the former with appropriate and far-reaching reorganizations and not to oppose the latter with the assumption of new risks. Italian banks Thanks to the interventions of the last few months, Italian banks are bolstering their liquidity and capital, an essential condition for tackling the significant deterioration in loan quality and profitability. Banks’ liquidity continues to improve, thanks in part to the partial reopening of the wholesale markets for funds. In January euro-area banks issued about €60 billion of bonds on the Euromarket, compared with an average of about €30 billion a month in the second half of 2009. Italian banks are well placed to cope with the international environment, which is being made more complex by the phasing out of support measures by monetary authorities and governments. Their capital bases have been strengthened by share issues, disposals of nonstrategic assets, the ploughing back of a large part of profits and, in some cases, public interventions. Between the end of 2008 and September 2009 the average core tier 1 ratio of the five largest banking groups rose from 5.8 to 7.3 per cent. The capital strengthening is continuing: it is necessary in order to increase banks’ ability to hold up under adverse macroeconomic scenarios. The market’s evaluation of the riskiness of banks has improved. The regulatory changes currently released by the Basel Committee for consultation will require Italian banks to make significant adjustments. They nonetheless start out from a better situation than other banking systems in terms of capital quality, having issued mostly high-quality capital instruments. The biggest impact could come from the proposal to deduct deferred tax assets from capital. For Italian banks such assets are considerable, owing to the restrictions in Italy on the tax deductibility of loan losses, which it is to be hoped will soon be revised. On this front the impact assessment will make it possible to evaluate alternative options, such as deducting only part of these assets, so as to attenuate the competitive distortions created by the differences in national tax treatments. Italian banks, which tend to engage to a greater extent in traditional forms of intermediation, have a low leverage by international standards. Measured by the ratio of total assets to tier 1 capital it was 24 for the largest groups in June 2009, as against 34 for the leading banks of the other European countries. The introduction of a prudential leverage ratio should therefore not have significant consequences. The same can be said of a tightening of the prudential requirements for trading books in view of the smaller share of innovative financial transactions and structured credit products in Italian banks’ balance sheets. The profitability of Italian banks has declined markedly, in parallel with the deterioration in the quality of their loans. In the first nine months of last year the net profits of the largest banking groups were down by 50 per cent compared with the same period of 2008 as a result of larger loan loss provisions. On an annual basis the return on equity fell from 9 to 4.2 per cent. In the third quarter of 2009 the ratio of new bad debts to outstanding loans to firms was above 3 per cent, its highest value in ten years. According to preliminary estimates, the deterioration in loan quality continued in the last part of the year, probably depressing banks’ results for the fourth quarter. The increase in substandard loans and past due instalments points to a further deterioration in the months to come. The priority use of the profits earned must be to strengthen banks’ capital bases. Credit In December the total stock of outstanding bank loans was 0.7 per cent lower than a year earlier. Lending to non-bank customers in the Centre and North was down by 1.3 per cent, while lending in the South recorded further growth of 2.7 per cent. The contraction in credit regards businesses, not households. In December the stock of loans to firms was 3 per cent smaller than in December 2008. On the one hand, demand for loans had fallen owing to the steep drop in investment; on the other, banks had become more cautious in supplying financing during a phase of deep recession. By contrast, lending to households has continued to grow at a twelvemonth rate of about 3 per cent. The expansion is concentrated in home mortgages, mostly variable-rate. The contracting parties must be warned of the risk they run in the event of rate increases. According to the latest surveys of banks, there is a moderate recovery in loan demand on the part of firms. Those engaged in technological upgrading and internationalization merit greater attention. The Government took various measures in the course of 2009 to strengthen the support provided by banks to small and medium-sized enterprises. Collective loan guarantee consortia will continue to play an important role in improving the conditions of access to loans and preserving the quality of bank credit. The statistical models employed by banks to rate borrowers are now using companies’ 2008 financial statement data; in the spring they will begin to process the data for 2009, which, if the recovery continues, could provide an outdated picture of the situation. It is necessary to supplement financial statement data with information gathered locally, review credit facilities in a more timely manner, refine screening procedures and establish balanced incentives for those who manage relations with customers. The Italian financial market Unlike bank lending, the bond market showed signs of recovery in 2009. Net issues by nonfinancial companies rose to exceed pre-crisis volumes. All the main industrial groups made bond issues. In the stock market, instead, both the number of listed companies and the ratio of market capitalization to GDP are down. The market capitalization ratio in Italy is one of the lowest among the advanced countries. Fund-raising by Italian mutual funds was negative again in 2009, albeit with signs of recovery in the final part of the year, confirming the structural nature of the crisis of the asset management industry. At the end of the year foreign funds had more assets under management than Italian funds. In order to enhance the autonomy and independence of asset management companies belonging to banking groups, in October we issued rules on the exercise of the parent company’s powers of direction and coordination. Groups must comply with them by June. To revive the sector, it is also necessary to intervene on the transparency and correctness of dealings with customers. The differences of tax treatment that penalize asset management products vis-à-vis competing instruments must be eliminated. Lastly, the asset management industry’s strategies and organizational arrangements need to be reviewed. As a consequence of the crisis a trend is taking hold, with strong encouragement from central banks and the Financial Stability Board, to shift over-the-counter trading to organized markets, to use central counterparties that can minimize the risks for individual participants and to centralize the data on contracts in so-called trade repositories. We hope the work by the European Commission to define a harmonized legislative framework will soon help to increase the transparency, liquidity and stability of the derivatives market, above all that in credit default swaps, which is most susceptible to speculative manoeuvres. Italy’s market infrastructures are at a decisive juncture. There is growing competition between organized markets and in post-trading. At European level the centralization of settlement is a tangible prospect and the development of a market patterned on our Collateralized Interbank Market is becoming a possibility. Italy has everything necessary to respond to these challenges. It has trading platforms for financial instruments and post-trading infrastructures that are at the cutting edge in Europe and integrated with the international markets. Wholesale trading in government securities takes place on a transparent and broad regulated market that held up well under the crisis and has recovered in the last few months. By international standards, the post-trading structures are among the least costly. Italian banks have significant ownership interests in the main systemic infrastructures; if they recognize their value, they can draw great benefits from them. Bank-customer relations The Bank of Italy has completed a broad survey – with more than 500 banks accounting for some 80 per cent of the current accounts supplied to customers – of the types and amounts of the fees applied to credit facilities and overdrafts. The results, transmitted to the Ministry for the Economy and Finance, to which the decrees assigned supervisory tasks regarding bank fees, were made available today on the Bank’s website. 1 They show a marked differentiation among the intermediaries: although there has been an overall reduction, in a third of the cases the charge has increased. The variety of new fees makes it difficult for customers to compare the different offers. The fee structure needs to be drastically simplified. New legislation to resolve the ambiguities of its predecessor would appear necessary. Within days we will submit to the Government a comprehensive regulatory proposal that can lead to clearly stated charges, so that all customers can compare different banks and competition can operate freely, without the impediment of opacity. For a month, new rules on transparency in banking and financial services and on the “basic current account” have been in effect. A major contribution to improving relations between intermediaries and customers comes from the institution of the Banking and Financial Arbiter, which has been in operation since 15 October. Customer appeals have come in steadily, and the panels have already handed down their first decisions. In a number of cases disputes were settled in the customer’s favour even before the Arbiter’s ruling. The initial signs are therefore very encouraging. The overall outcomes of customer complaints will be made public in April, providing useful information for supervisory action. http://www.bancaditalia.it/vigilanza/banche/questio/comm_banche.pdf (only in Italian). Supervisory action The action of the Bank of Italy in supervising banks and financial intermediaries is governed by a consistent logic. On-site inspections, off-site controls, measures on capital and liquidity, provisions on banks’ by-laws and managers’ compensation, and rules and controls for transparency and correctness in dealings with customers are all shaped by the assessment of the risks to which intermediaries are subject. Following the coordinated exercises conducted last year by the European supervisory authorities, a new round of stress testing of the major EU banks has begun in recent weeks. The results will be released by the end of June. Stress tests are by now an ordinary supervisory tool; the Bank of Italy, with the active participation of the banks, has promoted the corrective actions needed to refine and reinforce them. In 2009 we intervened repeatedly to remind banks of the need for full compliance with the rules on corporate organization and governance. For the cooperative banks, the aim has been to strike a balance between ensuring the stability of the governance structures approved by membership meetings and avoiding the risk of overly self-referential management. To this end we have recommended the amendment of by-laws to guarantee sufficient representation of minorities within the banks’ governing bodies and to facilitate membership participation at meetings through such means as increasing the number of proxies and allowing distance voting. Additional progress along these lines is all the more necessary when cooperative institutions move away from their original localist character to become systemically important intermediaries listed on regulated markets with complex business and group structures. The guidelines issued by the Financial Stability Board envisage two basic principles for bank managers’ compensation: that it must be tied to the risks taken; and that it must not jeopardize the preservation of the bank’s capital. We asked the six largest banking groups to verify that their compensation and incentive schemes are also consistent with the Financial Stability Board’s standards. The main open questions concern the proportion between the fixed and the variable parts of top management’s compensation, the introduction of medium and long-term incentives and methods for deferring the variable pay component, and the refinement of risk-adjusted performance parameters. The reports to the banks’ next shareholders’ meeting must give thorough information and precise data on their effective adaptation of contracts and incentive schemes to the regulations. A bank’s reputation also depends on how it prevents and combats money laundering. The new rules in effect since the start of the year on the single database to counter money laundering increase the traceability of transactions. Controls have been redoubled by means of new assessment procedures and dedicated analytical and inspection processes. Checks at individual branches, concentrated in the parts of the country considered to be at the greatest risk of infiltration by organized crime, are now being carried out in the inland areas of Campania, the Milanese hinterland and the province of Palermo. Capital repatriations under the foreign assets disclosure scheme (“tax shield”) need to be closely scrutinized by intermediaries in order to detect and report transactions that may be suspected of money laundering. So far, scarcely fifty reports of possible crimes in connection with transactions under the disclosure scheme have been received. This low number is explained only in part by the fact that the law abrogates the reporting requirement for a number of types of crime. The banks need to step up their commitment to careful scrutiny of the repatriation transactions. It is important to dispel all doubts over the way in which the anti-money-laundering rules are to be applied to these transactions. Italy’s foreign assets disclosure scheme will soon be examined by the Financial Action Task Force. * * * Little more than a year ago Italy was beginning to feel the full effects of a crisis that, following the failure of Lehman Brothers, had become global. It went into the recession with a low growth rate, one of the lowest in Europe. On the financial front our economy withstood the impact of the crisis better than many others: the soundness and prudence of the banks meant that support measures of the magnitude that weighed so heavily on the budgets of other countries were not necessary in Italy. But the loss of output and income has been enormous. The social protection network, though not systematically reformed, has rightly been extended to cope with unemployment, social hardship and neglect. We are now emerging from the recession with a low growth rate, one of the lowest in Europe. Rapid economic growth is the basis of well-being; for a country like Italy, with a large public debt, it is a prerequisite for financial stability. For the young, it means a future; for the old, decent living standards; our South would benefit from it and could be its engine. A precondition of rapid growth is structural reform, the lack of which has marked the loss of competitiveness that has been under way for fifteen years now. This is not a strictly Italian problem, it is common to the other countries of Europe. It lies at the origin of today’s fragility. European integration has brought price stability and, until the crisis, the effective control of public deficits. Ten years ago, at the launch of the single currency, there were calls for it to be accompanied by stronger economic management at European Union level; these voices were drowned out by the chorus of enthusiasts who celebrated the achievement together with the commitment to resist all further integration. The euro is sound. Clearly, a crisis that generates world financial instability will have an impact on the economies of the area that varies with the structures upon which they rest. It is essential that within the Union there form the common will to extend to economic structures and to the reforms they require the same careful verification and the same vigorous pursuit that have been devoted over the years to government budgets. | bank of italy | 2,010 | 2 |
Remarks by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, before the Committee on Economic and Monetary Affairs of the European Parliament, Brussels, 17 March 2010. | Mario Draghi: Modernisation of the global financial architecture – global financial stability Remarks by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, before the Committee on Economic and Monetary Affairs of the European Parliament, Brussels, 17 March 2010. * * * Thank you very much for having invited me to take part in this important debate between European and national parliaments. International and regional cooperation and national political leadership are essential complements for achieving global financial reforms; and the debate in this Committee is really helpful for that purpose. It is ultimately national and regional legislatures, accountable to their voters, that must decide and implement reforms. The strains in the global financial system have eased considerably in the last twelve months: the banks are once again raising funds, asset write-downs have diminished. Nevertheless, elements of fragility are still present in various parts of the financial system and risks, mainly related to the deterioration of traditional loan books, the bunching of refinancing needs in the next few years, and to new sources of risk such as sovereign risk. It is essential that we can count, in the years to come, on a fully restored ability of the banking sector to perform its essential tasks in the economy. We have come a long way towards strengthening the financial system since this crisis began. But we have hard work ahead of us to finish up. In my remarks, I will focus mainly on these forward challenges. But let me start by taking stock of where we have gotten to. Three things have been important in getting us to where we are now: First, the recognition that, in a closely integrated system, we all sit in the same boat; Second, the leadership of the G20 process, in which the EU has played an important role, in agreeing objectives and timelines for substantial reform; and Third, the establishment of mechanisms, such as the FSB, to hasten and coordinate the policy development needed to meet these objectives. When I say we have gotten far, I am speaking to an unprecedented amount of international dialogue and co-operation on important financial system issues, and the resulting substantive changes that either have or are about to come into place. While many issues remain to be resolved, in Europe, in the US and elsewhere, we are, collectively, fundamentally reshaping the framework for systemic financial oversight: First, top-down, system-wide oversight arrangements are being put in place at the national, regional and international level. These include more encompassing surveillance, with broadened macro-prudential perspectives, as well as mechanisms for triggering action on identified risks. Examples are the European Systemic Risk Board and related arrangements, the US Financial Services Oversight Council, the IMF-FSB Early Warning Exercise, and the establishment of the FSB itself. Second, as part of this, major jurisdictions and regions are overhauling their regulatory and supervisory structures to strengthen responsiveness to systemic risks, improve coordination and close gaps. The FSB is in many ways the international manifestation of these efforts; Third, the regulatory perimeter is being expanded. Major jurisdictions are finalizing legislation that for the first time establishes formal oversight over the OTC derivatives markets and its major dealers, hedge funds and credit rating agencies. In Fourth, we have put in place cross-border oversight and crisis management contingency planning for the largest and most complex global financial institutions, each of which now have functioning core supervisory colleges and crisis management groups. At the level of the essential regulatory policies to buttress financial stability, let me recall: That we are in the process of calibrating a fundamentally revised global bank capital framework which will establish stronger protection through improved risk coverage, more and higher quality capital, a counter-cyclical buffer and a constraint on the build-up of banking sector leverage; Second, we have developed and will implement a global liquidity standard for banks that will promote higher liquidity buffers and constrain the maturity mismatching that created the condition for this crisis; Third, we are making progress in developing a policy framework and tools to roll back the moral hazard risks posed by institutions that are systemically important; Fourth, we have eliminated the perverse incentives that pervaded securitization, including the scope for leverage to develop in opaque off-balance sheet vehicles through changes to accounting standards and regulatory and prudential rules; Fifth, we have developed a series of supervisory tools to raise standards of governance, risk management and capital conservation at core financial institutions. In this context, let me note that: – we are making strong progress towards a forward looking expected loss provisioning regime for credit losses which will dampen procyclicality and align accounting and prudential objectives in this key area; and – we are making good headway towards establishing compensation regimes that are better aligned with risks taken in significant financial institutions. I have been selective in my enumeration. But the point I want to make is that we should not underestimate what has been accomplished. Each of the above areas are difficult in their own right. That we have been able to progress global policy development and in cases implementation on such a broad front, while fighting a very serious financial crisis, is something that has never happened before. So, the direction in which we are moving internationally is encouraging. But as we hit the homestretch in the above areas, your political leadership will determine whether we accomplish credible and robust global reforms that deliver the protections that our citizens rightly demand, yet preserve the enormous advantages of an internationally integrated financial system. We must not only reaffirm our commitment to global solutions, but demonstrate our willingness to reach agreement on the issues that stand in their way. We cannot all have it our own way. In the process, we must guard against pressures to water down the stringency of global reforms. That such pressures originate within a financial industry concerned to preserve competitive advantages is not a surprise. But such pressures are also evident in hesitation by some countries about the impact of reforms on their own financial institutions. This hesitation is stronger where the starting point is weaker. However, it would be a very serious and unfortunate mistake to allow these different starting points to result in weaker standards than we need for the future. Given the economic and social costs of this crisis, we simply cannot afford sub-standard outcomes. And were we to fail, the risks is that countries and regions will go their own way and that the system will fragment, with very significant global costs. Hence, we must keep our focus on achieving global standards that are credible, and as part of this, agree transition and phase-in arrangements that enable all of us to move there. I will come back to this point. Let me speak to the key areas where we need to make headway in the months ahead. First and foremost, we must complete the revamp of the Basel capital framework and the liquidity standard, along with the complementary changes, including provisioning, that address the problems of procyclicality that we have seen in this crisis. We made a major step forward on this issue in December, when the Basel Committee released – on schedule – the full package of reform proposals. Comprehensive impact assessments are now underway to assess the consequences of the December capital and liquidity proposals on the banking sector. This is complemented by a top down assessment to calibrate the new minimum requirements, taking account of, among other things, loss experience over this crisis, and the impact on banks’ role in the financial system and the benefits and costs of the new requirements in the steady state. As I mentioned earlier, it will be critical that we do not let current strained conditions shape the standards, but instead keep our focus on the rigorous framework needed to ensure balanced, sustainable banking in the years ahead. While the banking sector has already made significant progress to raise the level and quality of its capital and liquidity, immediately implementing in full the more stringent minimum requirements could have negative effects. We will design appropriate transition and grandfathering arrangements that rule this out. We have set in train jointly with the Basel Committee, and with the IMF as a key partner, a thorough macroeconomic impact assessment to inform these phase-in and implementation arrangements. Preliminary results on all assessment streams will be available in June/July. Calibration work will continue into the fall, and the broad features of the framework, along with the transition arrangements, will be ready by the G20 Summit in November. Countries will need to pass any necessary legislation to implement the reform according to the agreed timetable, and the EU is at the forefront of this. Second, this year we must agree on measures to credibly reduce the moral hazard and systemic risk caused by firms that are “too big to fail”. TBTF is first and foremost a national problem – at worst when institutions are too big to save. But we are all affected by the moral hazard consequences of the problem going unresolved. There is no silver bullet or one-size-fits-all solution here. One focus of our work is therefore to provide supervisors with tools that enable them to take action in national contexts under existing authority – governance, intensity of supervision, structural simplification, capital surcharges, etc. Systemically important financial institutions have to be resilient even in periods of broad financial system stress events. Capital, liquidity and leverage expectations should reflect that. But we will never be able to fully eliminate the potential for failures, therefore a key requirement across all jurisdictions is the establishment of effective resolution frameworks that allow all types and size of institutions to fail, and adequate co-ordination of these frameworks across borders. This is a tall order, as we all know. However, should effective cross-border resolution prove out of reach, it will strengthen the case for alternative solutions: to place restrictions on activities/size/structure that make all institutions resolvable, or to raise capital and other requirements on systemic institutions to a point where the likelihood and impact of default is reduced to a very low level. This will come at a cost to intermediation and global financial integration. Given the diversity of institutions and financial systems involved, a key challenge will be to avoid inconsistencies in what results. We must achieve consistent design and implementation of new measures to ensure a level playing field and to address potential concerns about market fragmentation. Our aim is to reduce systemic risks globally by having standards for TBTF firms that set a common floor, and actions across countries that are sufficiently coordinated to avoid regulatory arbitrage. We will provide an interim report on these issues to the G20 Summit in June, and final recommendations to the November Summit. Third, we must finalise reforms to regulate, make transparent and centrally clear a substantial portion of the OTC derivatives markets, and so reduce their scope to act as channels of contagion. Legislation is advancing in the US and EU to establish the requisite frameworks for this. Among critical questions to resolve are: which derivatives products can and should be standardised, and ought to be subject to a mandatory central clearing requirement; whether, and if so how to define which type of, commercial end-users should be exempted from these requirements. We must be careful to avoid inconsistencies here, because this will drive regulatory arbitrage in this global market. To accomplish meaningful systemic risk reduction, we need robust globally agreed standards of soundness for all central counterparties. And governments should ensure that the determination of which derivatives should subject be to central clearing is not left to central counterparties alone. We also need harmonised definitions of standardised derivatives, and are setting in train work across the US and EU to this effect. It is also imperative that regulators have the information available to them to police the market for potential manipulative abuses. This is why there must be mandatory trade reporting of all OTC derivatives transactions, regardless of whether they are centrally cleared or bilaterally negotiated. Fourth, we must firmly embed reforms to compensation practices at financial institutions. As you know, the FSB set out Principles and Implementation Standards for Sound Compensation arrangements last year. In December, we launched a detailed assessment of implementation of these standards. This is a very important task not just because this is the FSB’s first peer review, but also because of the importance and political dimension of this topic. We are on schedule to conclude this review later this month. The review points to a key message – that a lot has been done by national authorities and that change is taking place in the major firms. However, differences remain in the approach to and pace of implementation. Greater progress has been achieved in the areas of governance, supervisory oversight and disclosure of compensation, while much more work needs to be done on pay structures and risk-alignment. We will be setting out additional recommendations in this area later in March. Concluding remarks At the outset, I noted that international cooperation and national/regional political leadership are complementary drivers for achieving global financial reform. Together, we have come a long way. But 2010 will be a critical year as we press ahead with global financial reforms. To maintain the momentum, we are critically dependent on your support. Indeed, internationally coordinated reforms cannot be agreed nor implemented without the support of national political leaders and those who are in a position to make final decisions. Your decisions, and those or your colleagues in other jurisdictions, will determine whether we are able to build a more robust and consistent global financial order necessary to preserve the advantages of an integrated financial system. Beyond the policy development work, full and consistent implementation will take time and perseverance. As I said, we must keep our eyes on the end objective, and we will develop transition paths to take us there. As we work to improve international cooperation and to further financial reforms, I hope we can count on the political support and leadership of all of you in this room. Thank you very much. | bank of italy | 2,010 | 3 |
Interview with Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, in Handelsblatt, Germany, conducted by Mr Hermann-Josef Knipper and Mrs Katharina Kort and published on 19 March 2010. | Mario Draghi: “We need a European economic government” – interview in Handelsblatt Interview with Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, in Handelsblatt, Germany, conducted by Mr Hermann-Josef Knipper and Mrs Katharina Kort and published on 19 March 2010. * * * Handelsblatt: The whole Europe is worrying about the Greek crisis. What can Greeks do to sort out its financial problems ? Mr Draghi: I think the best and only thing they can do is to come out with a credible fiscal adjustment plan to be implemented promptly. The more delayed the commitments are, the less effective they are on reducing spreads on government bonds. The quicker they do it the better, and I should say they started doing. The Commission and the ECB, and the IMF to some extent, were involved as well. They must have been persuaded by the fiscal plan. Of course we have now to monitor its timely implementation because that is as important as designing it. Greeks have clearly seen there is a political price to pay and that it is unavoidable. Handelsblatt: Are you confident in the Greek plans? Mr Draghi: Yes, but I would like to see its implementation. Handelsblatt: Do we need stricter rules? Mr Draghi: Yes, we obviously need stricter rules. It too early to specify which ones, but the Greek crisis has shown that this construction has to be made more resilient. Handelsblatt: What have you in mind? Mr Draghi: My opinion does not differ from the one expressed by your Minister of Finance, Mr. Wolfgang Schäuble. The first thing to bear in mind is that we were able to create a pillar of stability with the euro and we have to do everything to preserve it. No matter what many critics say, we had low inflation, low financing costs and we have been amazingly protected by the world turbulence because we had the euro. So we have to preserve the stability and the credibility of this concept. the Greek crisis has shown that this construction has to be made more resilient because it has shown potential cracks. Handelsblatt: What can be done to make the euro stronger? Mr Draghi: First of all we should ask ourselves why are markets so nervous, not only with Greece but also with other countries. Incidentally the spreads have gone up also on AAA rated countries, not only on the A or AA rated countries. Markets are nervous because financial market conditions have enormously worsened, within the euro and outside the euroarea. But the other reason for markets to be nervous is that they do not see clear on how we collectively will get out of the exit strategies. The first thing we have to do is to have a clear, well defined, well-timed exit strategy from the high budget deficits. This is on top of our list of priorities. Handelsblatt: Which is the second priority? Mr Draghi: I think we have to extend the Stability and Growth Pact. So far, we have been able to have a monitoring mechanism and to some extent an enforcing mechanism of the balance sheet. We have to reinforce this concept and extend it to structural reforms. The reason why countries do not grow is because they have not undertaken structural reforms which facilitate growth. Handelsblatt: Do you have anything specific in mind? Mr Draghi: For the people who have been part of the creation of the stability and growth pact this discussion goes back to the late nineties and it was suggested at that time by several people, myself included, that we should do more in making pension reforms, market reforms, competition reforms and so forth. These are the reforms that make you grow in the end. At that time, some of the countries objected that these things were so engraved in their history and social texture that they would not accept to have the same discipline that they could accept in the budgetary area. Handelsblatt: What are the implications in the present situation? Mr Draghi: I think it is now the time to make one step further. At least for the countries that are in the euro we need some mechanism that basically induces greater cooperation among governments and greater discipline. Ultimately, price stability, budgetary discipline and economic growth are the three pillars of financial stability. This refers to the medium term but we have to start working now because this will not be done in a month. Handelsblatt: What can be done in the short term? Mr Draghi: In the case of a fiscal crisis like the one in Greece, if we have a mechanism of identification and intervention that is clear, well-designed, markets will provide all the money that the countries want. What markets do not want is to be trapped in a confused muddled situation where they do not see clearly – a situation in which nobody would be ready to lend. If there is clarity and firmness of direction investors are there to lend the money. Only at the end of this, if we think we need some kind of emergency financial assistance like the one that Mr. Schäuble proposed, we can think about it. Handelsblatt: Do you agree with Minister Schäuble? Mr Draghi: The Minister rightly makes a point there. Now we have pooled monetary policy so it is considerably complex for the IFM dictate discipline to some country without saying anything on the monetary policy. Still, this is the other “macro-lever” of the IMF. Handelsblatt: Are you in favour of a European Monetary Fund? Mr Draghi: I think that if things are well done in laying out the monitoring and implementation mechanism probably you would not need a European monetary fund. We cannot think that the European fund would actually resolve the issue. I would not start from the financing of the crisis, but from the solution of the crisis. In the present market conditions, though, an emergency financing at rates higher than market rates, could only respond to temporary liquidity problems, but it would be wrong to make this mechanism the linchpin of our actions. Handelsblatt: Do we need a new structure for the enforcement mechanism? If so, what kind of structure? Mr Draghi: Not so much a structure, but we need a concept very much along the way we had with the stability and growth pact, a concept to be endorsed by the governments. Handelsblatt: Another Pact? Mr Draghi: Yes, another Pact. In the euro area we need a stronger economic governance providing for more coordinated structural reforms and more discipline. Handelsblatt: Going back to the EMF, do you think it might send the wrong incentives? Mr Draghi: This danger exists and we must do whatever we can to consider it just an emergency measure exclusively for liquidity purposes. Nobody wants to think about the Fund as a mechanism that could resolve the crisis. Countries must not relay on the availability of a fund where we can draw on when having difficulties. I don’t think that Mr. Schäuble or anybody thinks this. Handelsblatt: Would you recommend stricter rules for countries which do not respect the agreements? Mr Draghi: Yes, we need stricter rules providing for an economic and political cost higher than it is the case today for any deviation from the rules or for the use of financial means not coming from the market. Handelsblatt: Because of the financial crisis, rating agencies have been highly criticised. Do you think the Ecb should provide for its own ratings, as some have suggested? Mr Draghi: No, I do not think that would be right. The creation of an European rating agency could represent a solution if we have no trust in the American rating agencies or in any other. But this task should still not be entrusted to a central bank. Handelsblatt: Why have the experiences with credit rating agencies been so unsatisfying? Mr Draghi: Loopholes in regulations have allowed for conflicts of interest. One should wonder why the rating agencies did not see the big amount of dubious financial products being created between 2005 and 2008 and why they could not rate it properly. One of the answers is that the issuers were basically a few big investment banks. So, for some of these rating agencies it became clear that 90% of their business was done with these banks. This is exactly why they have been captured by the banks. Much has been done to change this, but there is still a lot do be done. Handelsblatt: What are you thinking of? Mr Draghi: We have a project in the FSB now where we, as regulators, are looking for a way to reduce the importance of rating in regulation. We must look for alternatives and define other mechanisms. Handelsblatt: But markets need ratings… Mr Draghi: Markets need rating. Investors want ratings. At the FSB we think there is the need for a better differentiation. One thing is a triple-A government bond, one other thing is a triple-A structured bond. It is always possible to have a structured bond in a way that it has a triple-A, even if the components are “junk”. So we must have ratings from the agencies which allow investors to distinguish one triple-A from another triple-A. Handelsblatt: When are we going to find a solution? Which are the further steps in the reform of financial regulation? Mr Draghi: One of the two most important projects the FSB now has is the capital and liquidity regulation, the reform of Basel 2. Its implementation is scheduled at the end of 2012. Handelsblatt: Is it right to fear that Basel III might limit credit flows, prejudging economic recovery? Mr Draghi: First of all I hope that by then the recovery will be on its way. There is a risk but I think fears are exaggerated. Banks have done a lot already in raising capital. We should reach a globally accepted definition of capital. The Basel Committee and the FSB are working so that the timing chosen for the implementation of the new rules do not prejudge economic recovery. Handelsblatt: Are you confident that we will have a globally coordinated regulation? Lately we have seen a lot of tension between the EU and the US. Mr Draghi: I think those tensions are being exaggerated. Many of the proposals now being publicly discussed, like the “Volcker rule” or a tax on banks in the US and the UK, have already been discussed by the FSB. Handelsblatt: You have been criticised for having worked at Goldman Sachs, the US investment bank accused of having been involved in dubious transactions with Greece. What can you tell us about it? Mr Draghi: When I left the Italian Treasury, in 2001, we had no rules in Italy forbidding to take a position in an investment bank. Nevertheless, I went to Harvard and taught for six months there. Then I entered Goldman Sachs. Since the beginning I made it clear that having worked 10 years with governments and government officials, it would be very embarrassing to ask them to do business with Goldman. I therefore insisted to develop my own clients in the private sector. And that’s what happened. I did that for about 3–4 years. Handelsblatt: Any country among your clients? Mr Draghi: No, I have never made any transaction with any government. The reason is simple: I was too busy doing corporate investment banking with private clients. Handelsblatt: Have you ever been to Greece? Mr Draghi: I have never been to Greece for working reasons. Those transactions were done before my arrival at Goldman Sachs. There have been further transactions with Greece but I have never been involved. I would also like to point out that I was not deputy CEO, because that position does not exist at Goldman Sachs. Handelsblatt: When you think now about Goldman Sachs and Greece, do you think it was a good idea for Goldman to help Greece mask its budget? Mr Draghi: That’s where the difference lies, the difference in purposes. One is debt management, the other one is debt concealment. That concealment is a very bad thing. If Greece had made a mess of their budget but not lied about the numbers, it would be much easier for them and for all of us. Handelsblatt: Which are the qualities of a good ECB president? Talking about monetary policy, do you consider yourself an “hawk”? Mr Draghi: You should ask ECB observers if they think of me as a “dove”. You must always keep in mind price stability and monetary policy credibility and their crucial importance for growth. | bank of italy | 2,010 | 3 |
Speech by Mr Fabrizio Saccomanni, Director General of the Bank of Italy, at the Chinese Academy of Social Sciences, Beijing, 15 April 2010. | Fabrizio Saccomanni: The global crisis and the future of the international monetary system Speech by Mr Fabrizio Saccomanni, Director General of the Bank of Italy, at the Chinese Academy of Social Sciences, Beijing, 15 April 2010. * * * The global crisis that hit the world economy since August 2007 has revived the long dormant debate about the adequacy of the institutional arrangements required to ensure stability in international economic and financial relationships on a global scale. The financial roots of the crisis have been widely analysed. Here, I intend to focus more on the macroeconomic drivers. I will try to argue that they are ultimately connected to a number of long-standing features of the international monetary system such as it has evolved since the demise of the Bretton Woods regime. I will then review the main options available to reform the international monetary and financial system. 1. The global crisis and its macroeconomic roots There is now a broad consensus that, even though the global crisis was triggered by dysfunctions in the financial system, unbalanced global macroeconomic conditions contributed to the accumulation of large financial vulnerabilities (Visco, 2009 and 2010). The proximate cause of the crisis was the US housing boom, financed by an unprecedented expansion of mortgage lending. Regulators’ failure to correct the incentive distortions introduced by financial innovation can largely explain the deterioration of lending standards, the widespread use of opaque financial instruments and the excessive risk-taking on the part of many international banks. Excessively easy monetary conditions contributed to encourage the rapid growth in mortgage borrowing and fed the rise in house prices. An easy monetary policy in the US and Japan – and, to a lesser extent, in the euro area – translated into a loose global monetary stance. Very low interest rates in main financial centers encouraged capital flows to economies with higher interest rates, which were induced to ease policy in turn, in order to avoid an excessive currency appreciation. Countries that pegged their exchange rate to the dollar effectively adopted the US monetary policy stance, and absorbed capital inflows by accumulating large official reserves. The investment of official reserves in US Treasury securities financed the growing US current account deficit and, at the same time, contributed to keep Treasury bond yields low. Investors turned increasingly toward riskier assets in their “search for yield”, leading to a compression of risk premia on a broad range of financial assets, from equities to corporate and sovereign bonds, thereby boosting asset valuations. National housing price cycles, usually mainly driven by country-specific factors, became highly synchronized globally. For several years this financial market exuberance went hand-in-hand with sustained global growth and price stability, thus feeding the illusion that the conduct of economic and especially monetary policy could reduce underlying risks, and that whatever risk was left could be easily diversified or shifted to those in a better position to bear it by efficient and sophisticated financial markets. The “speed limit” for the global economy appeared for a while to have been permanently raised, as the entry of China and other emerging economies in the global trading system effectively increased the world’s labour supply. At some point, however, bottlenecks emerged in commodity markets and global inflation picked up sharply. As monetary policy was tightened and housing markets peaked, also the degree of risk diversification turned out to be more limited and the risk management practices of financial intermediaries much less sound than it had been previously assumed. As the initial turmoil evolved into a fully-fledged crisis, the sharp fall in consumer and investor confidence translated into a dramatic and simultaneous contraction of demand, output and international trade, not only in advanced but also in emerging economies, which had hitherto been largely immune from the crisis’ fallout. The severity and the highly synchronized character of the world recession can only be fully understood by considering that the financial crisis had hit what had been until then the keystone of global economic growth, i.e. the ability of US consumers to continue borrowing and spending. Without that “consumer of last resort”, the whole edifice crumbled. 2. Flaws in existing international monetary arrangements There is a close connection between the macroeconomic imbalances that paved the way to the global crisis and some key features of existing international monetary arrangements. The Bretton Woods regime of adjustable exchange rate pegs collapsed in 1971–73 under the combined pressure of increased capital mobility and conflicting policy objectives among the largest economies. It has since been replaced by a “non system”, which is simply the result of individual countries’ choices among a broad menu of exchange rate regimes, ranging from monetary unions and hard pegs to freely floating rates. Market pressure resulted in the gradual removal of capital controls, first in industrialised countries and then, from the 1990s, in emerging ones, paving the way to global financial integration. At the same time, increasing trade integration continued to provide a strong motive for countries to try to avoid excessive exchange rate fluctuations, since large and persistent exchange rate movements are difficult to hedge against and discourage the establishment of trade relationships that require substantial long-term investment. Thus, contrary to predictions that increased capital mobility would lead to a polarization of exchange regimes around the extremes of either “hard pegs” or flexible exchange rates, many countries still adopt intermediate regimes, including various types of crawling pegs or managed floating. Individual countries’ exchange rate preferences can reflect a variety of structural factors and policy objectives. The result of these individual choices is a situation where a large number of countries de facto peg to the US dollar or actively manage their bilateral exchange rates with it; a smaller number of countries peg to the euro or to a basket; and several countries (mostly industrialized ones) allow exchange rates to float. This non-system lacks a mechanism capable of ensuring the global consistency of national objectives. The consequence has been a recurrent systemic instability (see Saccomanni, 2008): since the 1970s exchange rates among the major currencies have experienced very large fluctuations with serious consequences for the real economy. Periods of US dollar overvaluation have entailed the demise of important US manufacturing sectors and have been accompanied by strong protectionist pressures; on the other hand, when the dollar was weak, upward pressures on the yen and on European currencies destabilized the respective economies and greatly complicated the conduct of policies. For example, in Japan in the late 1980s the easy monetary stance to counter the yen’s appreciation allowed a huge speculative bubble to develop; the subsequent phase of yen appreciation in the early to mid-1990 exacerbated the economy’s slide into stagnation. the last thirty years have seen repeated episodes of currency and financial crises in emerging economies (the Latin America debt crisis of the early 1980s; Mexico in 1994; South-East Asia in 1997; Russia in 1998; Argentina in 2002). Although the proximate cause of each crisis could be identified in specific policy errors and structural/political weaknesses of the countries in question, a clear pattern recurs through all of them: a protracted underestimation of risks on the part of lenders, followed by an abrupt change in perceptions and a “sudden stop” in capital flows. The excesses of market optimism were usually connected to easy global monetary conditions, and the trigger of the crisis was often a monetary tightening in the United States. the past 10–15 years have seen a sharp widening of current account imbalances. The US deficit widened from 1.7 per cent of GDP in 1997 to 6 per cent in 2006 with, as a counterpart, growing surpluses in Japan, China and the oil exporting countries. The external imbalances largely reflected unbalanced domestic conditions: a sequence of asset price bubbles in the United States (the dot-com bubble in the late 1990s, the housing bubble after 2000); a sharp rise in saving and fall in investment in several Asian economies in reaction to the crisis of 1997; an extremely high saving propensity in China. A widely shared concern has been that current account imbalances could be at some point be regarded by the markets as unsustainable, triggering a sharp reversals of capital flows with destabilising consequences for the exchange rates of major currencies. Underlying these manifestations of global instability are some fundamental weaknesses of the existing international monetary arrangements. First, a well-functioning international monetary system must impose some form of discipline on national economic policies. In its original conception the Bretton Woods system assumed that the discipline would be based on a set of rules enforced collectively through the International Monetary Fund. Now the enforcement of discipline is entirely left to the markets and this poses several problems. First of all, its enforcement is far from uniform and symmetric: unsustainable current account surpluses are not sanctioned in the same way as deficits, and the country issuing the dominant reserve currency is largely immune, since it can finance deficits in its own currency as long as other countries are willing to accumulate reserves. Moreover, financial markets do not always sanction unsustainable policies consistently, because their perceptions of fundamentals can vary over time and are often overshadowed by other drivers of capital flows. After long phases of disregard for mounting risks, markets often react “too much – too late”, resulting in sharp “boom and bust” cycles. Thus, market reactions often encouraged authorities to act in highly pro-cyclical ways. Secondly, the international monetary system, like a domestic monetary regime, needs to provide a global anchor to stabilize inflation expectations, by ensuring that the monetary stance is appropriate on a global scale. The anchor, in earlier times provided by a link to gold, is now in practice dependent on the monetary policy frameworks of the major economies. However, even when these countries adopt a sound monetary stance, this does not automatically ensure an appropriate stance at a global level, since policies conducted with a narrow national focus may overlook global sources of inflationary pressures: the recent commodity price boom, driven by buoyant global demand, is a case in point. Moreover, countries that peg their currencies to the dollar (or otherwise shadow US monetary policy) effectively adopt the US policy stance. When many countries do this, the US monetary stance effectively becomes the prevailing stance in a large part of the world. This can lead to global monetary conditions that are either to easy or too tight for the world economy. A third important feature of the international monetary system is how it influences the demand for official reserves and how that demand is met. The global demand for reserves has increased enormously over the past 10–15 years: foreign exchange reserves rose from about 1.4 trillion US dollars in 1995 to 7.5 trillion in 2009. An important motive for reserve holding has been precautionary: official reserves allow authorities to offset capital outflows in the event of “sudden stops”, avoiding exchange rate depreciations or the need to seek conditional financing. Reserve accumulation could also be the by-product of an export-led growth strategy, as in the case of China. The accumulation of reserves by individual countries can, however, involve some important negative externalities for the global economy, as well as for the countries themselves. In order to accumulate reserves countries need either to run current account surpluses or to attract (and then usually sterilize) substantial capital inflows. To this end, they will compress domestic demand by implementing tight monetary and/or fiscal policies which may result, in the aggregate, in a deflationary bias on the world economy. In summary, the present arrangement is not able to enforce an effective discipline on national economic policies in a reliable, timely and symmetric way; it cannot ensure that the global monetary policy stance is appropriate to global conditions; and by encouraging countries to accumulate huge official reserves, which finance the current account deficits of the reserve currency country, it tends to feed large and persistent global imbalances. 3. The options for reform In reviewing the potential alternatives to the present “non-system”, a first necessary step is to clear the ground from seemingly “simple” and “automatic” solutions. A return to a regime of fixed exchange rates or a move to full and universal exchange rate flexibility are the two polar cases most frequently considered. I would argue that neither is feasible or desirable. 1 3.1 Exchange rate-based reform options A system of rigidly fixed exchange rates would be impractical (unless there was a political willingness to establish a single world currency) and would not be viable without a return to generalised restrictions on capital mobility. Capital controls would need to be very pervasive to have any effectiveness, implying prohibitive costs and setting back financial development by several decades. The option of free floating has in theory a number of advantages: i) it would not require to accumulate reserves to stabilize the exchange rate; ii) it would preserve monetary policy autonomy; iii) it would protect each country from external monetary shocks; iv) markets would enforce an effective and symmetrical discipline on national policies across all countries; v) it would avoid imbalances and instability as long as each country maintained its own house in order. The real world is, however, far from the idealized representation of the theory. When the hypotheses of perfectly flexible prices and costless adjustment are abandoned, and we consider the actual working of the financial system in a world of imperfect information and incomplete markets, the presumption that exchange rates will smoothly adjust to reflect changes in fundamentals soon appears unrealistic. In practice, changing market perceptions may make exchange rates volatile and lead them to diverge from fundamentals, especially where markets are thin and uncertainty high, as it is often the case in emerging economies. This experience explains why so many countries have displayed in practice a strong “fear of floating”. If we exclude the two “pure” exchange rate regimes, the only option available is that of a “managed” system based on international cooperation. However, it would be misleading to suppose that the starting point of any reform must be the choice of the exchange rate regime. There are other important features that deeply affect the functioning of the international monetary system: the role and effectiveness of international institutions; the multilateral surveillance process; the available mechanisms for creating international reserves; international trade rules and the mechanism for resolving trade disputes; and the regulatory framework for international financial markets. Not surprisingly, much of the recent discussion in the G20 on how to improve the functioning of the system has centered on these issues. For a detailed review of these issues, see Padoa Schioppa (2010). 3.2 Towards an SDR-based international monetary system? Before turning to the G20 strategy, I would like to review a proposal by Zhou Xiaochuan, the Governor of the People’s Bank of China (Zhou, 2009). After identifying a fundamental problem of the present international monetary system as stemming from the fact that a national currency is used as the main international reserve asset, Governor Zhou suggested that one of the goals of its reform should be creating “an international reserve currency that is disconnected from individual nations and is able to remain stable in the long run”. Indeed, “a super-sovereign reserve currency managed by a global institution could be used to both create and control global liquidity”. More specifically, he argued that the SDR, issued by the IMF, has the potential to become such a super-sovereign currency and that its role should be more actively promoted in the future, both through further increases in SDR allocations and by enhancing its use in international trade and in financial transactions. A proposal to increase SDR allocations has already been approved last year by IMF member governments; the new large SDR allocation, the first after many years, has effectively multiplied by a factor of 10 the outstanding amount of SDRs. Nevertheless, even after the latest increase, SDRs still represent less than 5 per cent of global foreign exchange reserves. The proposal that the IMF and the international community should actively promote the use of the SDR in trade an financial transactions is equally stimulating, and has been echoed by several academics and policy-makers. 2 At present, the SDR can be regarded as an international currency only in a limited sense of the term, because it is a basket of currencies, is not issued by a central bank, and its use is restricted to “authorised” institutions of the official sector. Countries cannot use SDRs directly to intervene in the exchange market, but need first to convert them into a “true” currency. In any case the possibility to use SDRs directly in interventions would require, first of all, the existence of a private SDR market. This, however, has never taken off in practice, even though no technical obstacles to it would seem to exist. In this regard, it is interesting to contrast the case of the SDR with that of the ECU, the basket of currencies introduced in 1979 in the context of the European Monetary System which eventually merged into the euro. While the use of ECU, much like the SDR, was restricted to transactions among official holders, during the 1980s and 1990s a large private market of ECU-denominated financial instruments developed. Substantial amounts of ECUdenominated bonds were issued and an interbank market in ECU deposits developed, supported by an agreement among a group of private banks to establish an ECU clearing arrangement, as well as markets in a wide array of ECU derivative instruments. In this context European central banks acquired reserves in private ECUs, which could be used to carry out interventions directly in ECU. The rapid growth of a private ECU market benefited from the support of Community institutions and some national official institutions (including the Bank of England), which issued debt denominated in ECU, thus providing the critical mass that helped the market to take off. Moreover, EU institutions assured legal certainty of the definition of the ECU basket and its continuity. As in the case of the ECU, instruments denominated in a basket – like the SDR – that included all the major currencies would represent a natural hedge for companies whose business is global. Once a liquid market for SDR instruments existed, it should be attractive for such companies to manage the bulk of their financial operations in SDRs rather than in the individual currencies. The crucial difficulty, however, is reaching the critical mass that would allow the development of a deep, diversified and liquid market, where transaction See for example Williamson (2009), Kenen (2010) and Padoa-Schioppa (2010). For a discussion of the issue of reforming the international monetary system, see Greenwald and Stiglitz (2008), Bergsten (2009), Eichengreen (2009), Cooper (2009), Mateos y Lago et al. (2009). costs would be sufficiently low that the natural advantages of the SDR can emerge. Given the inertia that comes with network externalities and economies of scale and of scope, reaching such a critical mass would be virtually impossible unless public policy plays an active role. The type of actions that were used to foster the development of the ECU market could be a starting point. 3 Over time, the SDR could become widely used in trade transactions. Producers of internationally traded commodities may want to set prices in a unit that is a much better proxy than the dollar of the composition of their imports. This, in turn, would encourage trade invoicing in SDR, creating a further inducement for countries to hold reserves in SDR. It is likely that for the SDR, incentives to its use as a unit of account, means of payment and store of value would be mutually reinforcing. Enhancing the role of the SDR may require, at some point, revising the composition of the SDR basket in order to make it more representative of the world’s main economic regions. Two elements should, however, be kept in mind: first, for operational reasons, it would be preferable to continue to restrict the basket to a limited number of major currencies; second, all the component currencies should be fully convertible and have well developed financial markets with full capital mobility, since by allowing arbitrage to keep the valuation of SDRbased instruments in line with that of instruments in the component currencies, this would facilitate both their development and their acceptance. This implies that the inclusion of the Chinese renminbi in the SDR basket, highly desirable on economic grounds, may nonetheless need to be postponed until sufficiently developed and open renminbi financial markets exist. It is important now to ask in which ways an enhanced role of the SDR could contribute to address the fundamental flaws of the existing international monetary system. This is a complex question and I have only some tentative answers. First, once the SDR becomes a true reserve asset, there would be an incentive for countries with a broadly diversified set of trading partners to manage their currencies with reference to the SDR, while those that are closely integrated with one particular region could continue to maintain a link to a regional currency (the dollar, the euro and, in the future, the renminbi). Countries that peg or manage exchange rates vis-à-vis the SDR would presumably choose to accumulate reserves in SDRs rather than in US dollars. Second, regular IMF allocations of SDRs, and the fact that these would be regarded as “true” reserves, would help diminish the pressure for countries to try to accumulate other currencies by maintaining undervalued exchange rates and sterilizing capital inflows, which in the recent past has been a driving factor behind the widening of global imbalances. I think these effects would be important contributions to a more balanced and stable system, although they would be felt only gradually as the SDR increases its role. Still, two important issues would remain unresolved. First, exchange rates among the major currencies may continue to undergo wide fluctuations, even though these may have less destabilising effects on third currencies to the extent that many of these would be linked to the SDR. Second, since the SDR would remain a currency basket without its own central bank, the “global monetary stance” would continue to be a “weighted average” of the stances of the major economies. Although IMF decisions on SDR allocations and cancellations could potentially influence the stance, the complex and politically-charged decision making process on SDR allocations may not be suitable for conducting an efficient monetary policy on a global scale. For example, national governments and multilateral institutions could start issuing SDR-denominated debt on a regular basis. Once a sufficient volume of debt instruments at different maturities exists, the market itself can be expected to develop derivative instruments based on them. Moreover, it should not be too difficult for international institutions, working with private banks, to foster the establishment of a clearing arrangement for private SDR deposits. Ways could also be found to connect the private and the official SDR market (something that did not exist in the case of the ECU), either by easing the legal restrictions on the use of official SDRs or through an institution acting as a clearinghouse. In order to facilitate the transition to an SDR-based system, it may in any case be necessary to set up at the IMF SDR-denominated reserve accounts where members could deposit their currency reserves and obtain in exchange SDR deposits, as suggested by Governor Zhou. This closely resembles the idea of a “Substitution account”, which has a long history in international monetary reform negotiations in which I was personally involved (Micossi and Saccomanni, 1981). In the broader context of Governor Zhou’s proposal, this could be seen as a way of smoothing the transition to an SDR-based system, avoiding the uncertainty and potential currency instability associated to the shift in the composition of global reserves (Kenen, 2010). The rationale for establishing a “Substitution account” is twofold. First, it would allow countries to rebalance their reserve composition through off-market transactions, thus avoiding undesirable exchange rate effects of the liquidation of large amounts of dollar reserves. Second, it would also be possible to share or shift the exchange rate risk from the original holders of dollar reserves to other parties. This second result, however, would depend on the specific technical arrangements. 4 Clearly, the financial implications of the alternative risk-sharing arrangements would be very different, and would depend crucially on how exchange rates are expected to move after the reserve transfer. The negotiation of any arrangement of this kind should therefore presumably be part of a more general agreement on a reform of the international monetary system. To the extent that such a reform would remove the underlying structural roots of the dollar’s weakness, it could also help make the exchange rate risk more acceptable (see Williamson 2009; Kenen 2010). 4. The G20 reform process A crucial test of the commitment of policy-makers in the major countries to address the weaknesses of the existing global monetary and financial system and to set the global economy on a sustainable growth path will be the outcome of the ongoing efforts to rebalance global demand through enhanced policy coordination. This effort is currently centered around the so-called “Framework for Strong, Sustainable and Balanced Growth” launched by the G20 last year in Pittsburgh (Saccomanni, 2010). It envisages the identification by each G20 country of detailed policy measures aimed at achieving the agreed common objectives, with a mutual assessment process, assisted by the IMF, where the adequacy, consistency and effective implementation of those measures will have to be evaluated. The choice of the G20 as the leading forum for cooperation was dictated by the need to strengthen the legitimacy of the process, recognising that a global readjustment could not be treated as a bilateral affair between a few major countries – no matter how big – or that it could be left to the interplay of foreign exchange markets. Every effort must be made to ensure that the G20 process is successful. A failure would have serious implications for the growth prospects of the world economy and might set in motion renewed tensions in the global financial system and in exchange rate relationships. Europe is deeply committed to play its role in the adjustment process. Although individual countries within the euro area have non-negligible surpluses or deficits, the area as a whole runs an approximate balance and it has been able to absorb the impact of a dollar depreciation of 45 percent vis-à-vis the euro between early 2002 and mid-2008, only partially For example, if the dollar reserves were simply transferred to the IMF and the deposits acquired by reserve holders were denominated in SDR, the exchange risk would be shifted to all IMF members according to their quotas. If, however, the resulting IMF claim vis-à-vis the United States were also denominated in SDR, the US would then bear the risk (effectively giving an SDR guarantee on its dollar liabilities). The risk sharing problem is not regarded by most authors as insuperable. See Alessandrini and Fratianni (2009) and Kenen (2010). compensated by the dollar appreciation recorded since then. Since the crisis, the need to take measures to deal with its internal imbalances and to restore growth and competitiveness of its members has become an important policy priority for the European Union, as reflected in the EU 2020 Economic Program recently presented by the European Commission. A firm commitment has been undertaken at the highest political level to take “determined and coordinated action to safeguard financial stability in the euro area as a whole”. In the G20 strategy, the process of rebalancing and sustaining global growth is expected to be supported by complementary efforts to liberalise the trade system and to strengthen financial regulation. A commitment to maintain an open multilateral trading system has been strongly reaffirmed in every G20 statement, together with the objective of reaching “a successful conclusion of the WTO’s Doha Development Agenda with an ambitious and balanced outcome”. But progress in this delicate area has been mixed. Anecdotal evidence provides confirmation of the fact that “low intensity protectionism” is spreading. Over 450 protectionist measures have been introduced last year by G20 members, both industrial and emerging countries, of which one-third against China. The Doha negotiations, moreover, continue to be hampered by disagreements among industrial and emerging countries and that the practice of bilateral and regional trade agreements continues to pose a threat for the multilateral nature of the world’s trading system. Work on reforming the financial regulatory system is well under way under the aegis of the Financial Stability Board (FSB). The main areas of this critical work include: strengthening the global capital framework (by building stronger buffers into the financial system, covering capital, liquidity and provisioning); making global liquidity more robust (by introducing new minimum liquidity standards and a structural ratio to address liquidity mismatches); reducing the moral hazard posed by systemically important institutions (by envisaging specific additional capital, liquidity and prudential requirements to reduce the complexity of group structures); strengthening accounting standards (with the transparency and the mitigation of pro-cyclicality); expanding oversight of the financial system (to ensure that all systemically important activity – such as that of the hedge funds and credit rating agencies – is subjected to appropriate oversight and regulation); strengthening the robustness of the over-the-counter (OTC) derivatives market (strengthening capital requirements and incentives, moving to central counterparties or organized exchanges); objective of convergence, The enormous complexity of the technical issues at stake, the strength of conflicting vested interests and the expanded number of participants in the negotiations explain why the process of financial reform is still underway more than two years after the outbreak of the crisis. Nevertheless, a high degree of consensus has been reached on the main components of the reform and it seems unlikely at this stage that the process will be stalled. *** The outline of a new international monetary system is being drafted within the G20 and in the broad fora of the academic community of the public opinion. The main pillars of a new system – a stability oriented anchor for macroeconomic policies; an open multilateral trading system; a more resilient and risk-averse regulatory regime; a reserve regime based on a multilateral asset – are in different stages of construction. The world economy shows signs of recovery but it is essential that the pace of reform is not slowed down. It is imperative to reduce significantly the risk for the world economy of a devastating crisis such as the one we have just experienced. This requires to tackle the potential sources of instability that lie in our very imperfect international monetary arrangements. References Alessandrini, P. and M. Fratianni (2009), “Dominant currencies, Special Drawing Rights and supranational bank money”, World Economics, Vol. 10, No. 4, Oct./Dec. Bergsten, C.F. (2009), “The dollar and the deficits”, Foreign Affairs, Vol. 88, No. 6, November/December. Cooper, R. (2009), “The future of the dollar”, Peterson Institute for International Economics, Policy Brief PB09–21, September, http://www.iie.com/publications/pb/pb09–21.pdf. Eichengreen, B. (2009) “The dollar dilemma”, Foreign Affairs, Vol. 88, No.5, Sept./Oct. Greenwald, B. and J. Stiglitz (2008), “A modest proposal for international monetary reform”, International Economic Association Meeting, Istanbul, June, http://www0.gsb.columbia.edu/ipd/pub/Modest.Proposal.COMBINED.pdf. Kenen, P. (2010), “The substitution account as a first step toward reform of the international monetary system”, Peterson Institute for International Economics, Policy Brief PB10–6, March, http://www.iie.com/publications/pb/pb10-06.pdf. Mateos y Lago, I., R. Duttagupta and R. Goyal (2009), “The debate on the international monetary system”, IMF Staff Position Note, SPN/09/26, November, http://www.imf.org/external/pubs/ft/spn/2009/spn0926.pdf. Micossi, S. and F. Saccomanni (1981), “The substitution account: The problem, the techniques and the politics”, BNL Quarterly Review, No. 137, Nov.–Dec. Padoa-Schioppa, T. (2010), “The ghost of Bancor: the economic crisis and global monetary disorder”, speech at a Conference organized by the Foundation International Triffin, http://www.notre-europe.eu/uploads/tx_publication/Speech-TPS-LouvainLaNeuve25.02.2010.pdf. Saccomanni, F. (2008), Managing international financial instability. National tamers versus global tigers, Edward Elgar Publishing. Saccomanni, F. (2010), “Turning the page on an era of irresponsibility”, The International Spectator, Vol. 45, No. 1, March. Visco, I. (2009), “The global crisis: the role of policies and the international monetary system”, paper presented at the G20 Workshop on the global economy, Mumbai, India 24– 26 May 2009, http://www.bancaditalia.it/interventi/intaltri_mdir/Visco_250509.pdf. Visco, I. (2010), “Global Imbalances, the Financial Crisis and the International Monetary System”, World Economics, Vol. 11, No. 1, January–March 2010, forthcoming. Williamson, J. (2009), “Why SDRs could rival the dollar”, Peterson Institute for International Economics, Policy Brief PB09–20, September, http://www.iie.com/publications/pb/pb09– 20.pdf. Zhou, X. (2009), “Reform of the international monetary system”, People’s Bank of China, March, http://www.pbc.gov.cn/english//detail.asp?col=6500&ID=178. | bank of italy | 2,010 | 4 |
Concluding remarks by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the Ordinary Meeting of Shareholders 2009 - 116th Financial Year, Bank of Italy, Rome, 31 May 2010. | Mario Draghi: Overview of economic and financial developments in Italy Concluding remarks by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the Ordinary Meeting of Shareholders 2009 – 116th Financial Year, Bank of Italy, Rome, 31 May 2010. * * * Ladies and Gentlemen, The reorganization of the Bank of Italy’s branch network to enhance the efficiency of its essential functions, which was begun in September 2008, proceeded on schedule last year. A total of 39 of the original 97 branches have ceased operations, and another 25, specializing in services to users, have been streamlined. In six provinces detached units of the corresponding regional branches have been instituted to perform banking and financial supervisory functions. The reorganization is to be completed this year with the specialization of six branches in cash handling. Permanent savings of some €80 million a year have been achieved. The systematic revision of organizational arrangements and operating processes that was begun in 2007 continued at the central administration as well, last year focusing on banknote production. The use of more advanced technology and the changeover to simpler procedures produced gains in efficiency and in the quality of services to the banking system and to citizens. In a year of economic and financial crisis and of management and operational challenges to our organizational structures, the skill and dedication of the staff have been decisive. The Bank of Italy will contribute to next year’s celebration of the 150th anniversary of Italian unification with two initiatives. A research project entrusted to Italian and foreign historians, economists, and legal scholars will examine the ability shown by our economy to adapt to changes in the international environment over the past century and a half. Next spring we will hold an exhibition on Italian monetary unification – a little known but crucial aspect of the broader process of national unification. The evolution of the crisis and international cooperation Twenty months ago the collapse of Lehman Brothers opened up grim prospects for global finance and the world economy. The action of monetary authorities and governments staved off the collapse of confidence among financial operators, savers, investors and consumers. In the G7 countries as a group, public financial support for the economy exceeded 5 percentage points of GDP in 2009. Real short-term interest rates turned negative and the central banks provided unprecedented volumes of liquidity. Output declined by 2.4 per cent in the United States, 4.1 per cent in the euro area, and 5 per cent in Italy; GDP continued to expand in the emerging economies, although slowing to growth of 2.4 per cent. This year the leading international institutions predict that world output will grow by more than 4 per cent. However, this is the average of widely disparate rates: high in the emerging economies, above all China; substantial in the United States and Japan; and weak in Europe, where output is still well below the pre-crisis level. Government budget deficits and public debt have spiralled. Relief at having avoided catastrophe has given way on international financial markets to apprehension about the sustainability of growing sovereign debt. Sales target the government securities of countries with large budget deficits and high levels of public debt, in particular those that combine these two characteristics with weak economic growth. The weaker this growth, the more exacting and pressing are the demands by international investors for a rapid adjustment of imbalances in the public finances. These countries have no alternative but to map out promptly a path to restoring budgetary equilibrium, with a reallocation of current expenditure and with structural reforms aimed at raising potential output and competitiveness. These are difficult courses of action and unless coordinated at international level they risk extinguishing the hesitant recovery. The crisis has attenuated, not eliminated, the worrying geographical imbalances in world demand. The curbing of debt and increase in saving in the United States and some European economies are compressing consumption and investment; they should be offset, more than is already happening, by stronger expansion in domestic demand in the countries that have built up large external surpluses. In Pittsburgh last year the G20 launched an ambitious programme of multilateral surveillance of macroeconomic and structural policies. It is important that this be translated into concrete strategies to restore balance and support growth. However, it is probable that the process will not be rapid; the deficits will need to be financed, requiring sound and transparent markets. Lessons from the crisis The roots of the crisis that has beset the world for nearly three years lie in regulatory and supervisory deficiencies in the main financial centres. The expansionary monetary policy conducted by the United States from the end of the 1990s helped to create a financial environment conducive to the explosion in private debt and the aggravation of global imbalances; these factors heightened the effects of the crisis and fostered their transmission. Clear indications derive from this for the future, regarding both the system of financial regulation and monetary policies. From the start of the crisis the Financial Stability Board was entrusted by the world’s highest political authorities with responsibility for designing the regulatory framework in which the financial industry will operate in the years to come. On several occasions I have described the guidelines that continue to inform this plan; how they draw from the diagnosis of past weaknesses a model for present and future action; and how the ultimate objective of this work is to make the system more resistant to crises. Some crises may be prevented, others will be inevitable; but we can take action to limit their damage and contagion. The agenda develops in four directions: (i) draw up general rules for the banks: a more robust capital base, lower financial leverage and control of liquidity risk are the pillars of this; (ii) introduce specific provisions for systemic intermediaries designed to reduce the likelihood of their failing, enable their orderly administration if this should happen, and prevent contagion; (iii) reduce the importance of ratings in supervision, while simultaneously increasing the competition between rating agencies and exercising effective control over the integrity of their decision-making and the transparency of their evaluations; (iv) increase the transparency of trading on regulated financial markets; and bring overthe-counter markets back within a framework of universally accepted rules that impose standard contracts and the settlement of trades with central counterparties that are subject to supervision. The first set of reforms requires the utmost international convergence, otherwise regulatory arbitrage and market integration will preclude their effectiveness. For the second set it would be more appropriate to talk of minimum harmonization: all countries should adopt measures in respect of systemic intermediaries, but it is illusory to imagine that the method and timing of their implementation will be the same across countries because differences in institutions, markets, business models and economic history are too great. Only when governments and regulators can allow the institutions that deserve to fail to do so without causing a catastrophe such as that following the collapse of Lehman Brothers will they have regained true independence from the financial services industry. In the United States an ambitious project to reform the regulation of the financial system is taking shape; for the aspects bearing most closely on international cooperation it is in line with the agenda of the FSB, whose work is proceeding according to schedule. However, this year’s appointments will be decisive. The most important deadline is the presentation to the G20 Summit in Seoul next November of the new rules reforming the Basel II Accord. The financial industry contends that the regulatory reform could impede the recovery. But the application of the new rules will be gradual and will not begin until the recovery has gathered force. The changeover to the new definition of banks’ capital will be long enough to render its effects on banks’ market value and on credit negligible during the transition. It is important that the difficulties of the moment not lead to a loosening of the long-term objectives, which must be kept firm. The experience of the crisis also influences the design of monetary policies. Their objective continues to be price stability, but they must be more prepared to counter developments in credit and money that can fuel financial disequilibria, even in the absence of immediate inflationary dangers. Our analyses, among others, show that in order to attenuate the volatility of credit, financial asset prices and economic activity it is also necessary to prepare instruments such as countercyclical variations in banks’ capital requirements or in loan-to-value ratios. This is what is known as macroprudential policy. The central banks must play a role in designing and implementing it. In times of severe crisis the balance sheets of financial intermediaries are altered and, with them, the monetary policy transmission channels. The constraints on the availability of credit, which are only marginally binding in normal times, become stringent when the markets do not function in an orderly manner; support for credit has a much greater effect on the economy than the expansion of the monetary aggregates. Changes in the size and composition of central banks’ balance sheets have proven useful in the efforts to stabilize the markets. This is what the ECB has done and is doing. The euro area Euro-area monetary policy has been strongly expansionary for some time. It has ensured orderly conditions in the credit system and provided support for the recovery of the economy in a context of moderate inflation expectations firmly anchored to price stability. The exceptional liquidity expansion measures averted a systemic crisis; they pushed down interest rates in the money market and helped to reduce those on loans to firms and households. In order to extend intermediaries’ access to funds, refinancing operations were conducted at a fixed rate and with full allotment of the amounts requested; the range of financial assets eligible as collateral was widened; the maturity of operations was lengthened to twelve months. At the end of last year, the Governing Council of the ECB, while not renewing some exceptional measures it deemed no longer indispensable, continued to provide all the liquidity necessary to support the economy and the financial system. But in the last few months the consequences of the crisis have tested the cohesion of the euro area. The massive creation of public debt, in a phase in which extraordinary quantities of bank bonds are falling due on the markets, suddenly increased the risk premium on some sovereign debtors. For Greece, the question had been posed for some time: the loss of credibility of the public finances, the magnitude of the budget deficit, the public debt and the external current account deficit, low growth, and the country’s weak industrial structure and unsustainable wage dynamics were pitching Greece into a fiscal crisis that the country’s authorities were slow to recognize. Just as in the case of American private debt, political indecision and the absence of crisis resolution mechanisms aggravated the situation. In the Greek case the difficulty of finding a European accord on a rescue plan, but also the unavailability of a process permitting orderly management of the debt crises of sovereign states, amplified the damage and the contagion and at the same time heightened moral hazard. What was paralyzing the markets was the prospect that Greece’s fiscal crisis might lead, through a deterioration in the quality of collateral, to a collapse of the country’s banking system, which would no longer have had access to ECB refinancing. In addition, there were fears for other countries’ banks with large exposures to Greek counterparties. The risk was becoming systemic: interbank liquidity was evaporating, the stock markets were plunging. The ECB and the national central banks intervened promptly, maintaining the option to accept lower-rated collateral; reactivating the unlimited supply of liquidity in long-term refinancing operations; and initiating, with the Securities Markets Programme, purchases of securities in order to resuscitate markets that had become illiquid. The governments of the euro-area countries and the European Union, in agreement with the International Monetary Fund, allocated €110 billion for loans to Greece and prepared a mechanism able to mobilize up to €750 billion in financial assistance to euro-area sovereign debtors hit by a liquidity crisis, with a contribution of the IMF. The beneficiary countries will have to draw up adjustment programmes which, if approved by the European Council, will be subject to periodic verification. In evaluating the exceptional circumstances that justified intervention in the government securities market, the Governing Council of the ECB considered that the functioning of the monetary policy transmission mechanism was endangered and the stability of the euro’s financial system at risk. The ECB sterilizes these interventions, which do not finance public deficits. Its independence is not in question. These measures will have to be discontinued as quickly as possible, as soon as the markets spontaneously resume trading of the securities of the countries involved. This will require rapid, significant and discernable progress in adjusting government budgets and the fully operational status of the financing mechanism set up by the European Union and the IMF. But enduring stability of the markets can only come with the resumption of growth, for it must not be forgotten that this crisis is above all a crisis of competitiveness. The recent events pose, again and more powerfully, the old problem of European economic governance. A strengthening of the Stability and Growth Pact is urgent. The commitment to achieve a structural budgetary position in balance or in surplus must be made cogent by introducing sanctions, including political sanctions, for non-compliance; the accuracy of statistical information, particularly public finance statistics, must be ensured. Cogent constraints and commitments must also be introduced for structural policies. The disparities we have been witnessing for some time in actual and potential growth rates and the seriousness of the imbalances in intra-area trade in goods and services signal inadequacies and inconsistencies in national policies. Some objectives of public action to enhance economic growth in the long run, for example those bearing on the labour market participation of both the young and the old and on competition in the markets for services, should be accompanied by controls and, in some cases, sanctions. The Italian economy In the two years 2008–09 GDP contracted by 6.3 per cent, almost half the entire growth achieved in the ten preceding years. Households’ real income diminished by 3.4 per cent, their consumption by 2.5 per cent. Exports fell by 22 per cent. Rapidly spreading uncertainty and the deteriorating outlook for demand led firms to cut investment, causing it to contract by 16 per cent. Wage supplementation rose to 12 per cent of total hours worked in industry at the end of 2009. Employment decreased by 1.4 per cent, the number of hours worked by 3.7 per cent. Some 9,400 firms became involved in bankruptcy proceedings in 2009, a quarter more than in the previous year. The firms hardest hit are the smallest ones, which often depend on subcontracted work. Those that had embarked on restructuring before the crisis have withstood its effects better and now have the best prospects. According to the Bank of Italy’s periodic survey, they expect their turnover to increase in 2010 by 3 percentage points more than that of comparable firms that had not restructured. Industrial firms with 50 or more employees that had invested in R&D in the three years preceding the crisis expect their turnover to increase by more than 6 per cent. Economic policy limited the damage, containing the fall in GDP by an estimated two percentage points, of which about one point can be attributed to monetary policy, half a point to the automatic stabilizers built into the budget and the rest to the recomposition of revenue and expenditure enacted by the Government. The extension of income support programmes attenuated the immediate costs of the crisis. The increase in the budget deficit was smaller than in the other main advanced economies, thanks in part to the solidity of the banking system, which did not need significant public support. In the other G7 economies this amounted to 3.8 per cent of GDP on average. At the beginning of this year it was estimated that the Italian economy would return to the, albeit modest, growth of the ten years preceding the crisis. In the first quarter GDP grew by 0.5 per cent compared with the previous quarter; there was an improvement in the opinions of firms, especially exporters, regarding the performance of orders and their expectations for production. Destocking appeared to have come to an end. The explosion of the Greek crisis could change the outlook. Some European governments have taken action to reduce their budget deficits. The Italian Government has reaffirmed the objective of bringing the deficit below the threshold of 3 per cent of GDP by 2012, confirmed the commitment to achieving budgetary balance over a longer time horizon, and brought forward the formulation of the adjustment measures for 2011–12. According to the official estimates, the measures recently approved by the Council of Ministers will reduce the baseline budget deficit in 2012 by €24.9 billion; the measures bear on the main items of expenditure and focus on the operating costs of the public administration. The package is intended to slow the annual growth in primary current expenditure to below 1 per cent in 2011 and 2012, thereby reducing its ratio to GDP by more than 2 percentage points. Over the last ten years expenditure expanded at an average annual rate of 4.6 per cent and rose by nearly 6 percentage points in relation to GDP. Careful monitoring of the effects of the package will therefore be needed to ensure the objectives are achieved. Italy’s financial structure has many strong points. Household wealth, net of debt, is nearly 2 times GDP, considering just the financial component, and about 5.5 times GDP, including real estate. These levels are among the highest in the euro area, while the household debt ratio is among the lowest and that of firms is below the average. The net external debt position of the entire economy can be estimated at 15 per cent of GDP, one of the lowest values in the euro area, except for Germany, which has a large credit position. The ratio of public debt to GDP declined by 18 percentage points between 1994 and 2007. In the last two years of recession it increased by 12 points, to stand at 115.8 per cent. In the new market conditions action had to be taken even though the budgetary tightening adversely affects the prospects for economic recovery in the short term. Competitiveness and growth In the Monetary Union stagnation, unemployment and, in the long run, budgetary strains are the inevitable consequence of the loss of competitiveness. The consolidation of the public finances needs to be accompanied by the revival of growth. In the ten years preceding the crisis hourly productivity rose by 3 per cent in Italy, by 14 per cent in the euro area. In the same years the economy grew by 15 per cent in Italy, as against 25 per cent in the euro area. Italy’s employment rate remains low, 57 per cent in 2009, 7 percentage points less than in the euro area as a whole. The gap is wider for the young and reaches 12 points for women. On many other occasions we have addressed the question of structural reforms. The crisis makes them all the more urgent: the fall in GDP increases the burden of financing the public administration; the costs imposed by tax evasion and corruption become even more unsustainable; stagnation destroys human capital, especially among the young. The management of turnover in the public sector and the cuts in the discretionary expenditure of government departments recently decided by the Council of Ministers must provide the opportunity to rethink the scope and structure of government, rationalize resource allocation and reduce waste and duplication between different entities and levels of government. A reform plan covering the entire public sector is needed, to accompany the measures already adopted to raise the productivity of the public administration by evaluating the performance of managers and the results of individual units. Fiscal federalism must enhance efficiency in the use of resources. Only a strong budgetary constraint, together with the necessary taxing power, can make the fiscal cost of each decision transparent and cost centres accountable. The specification of the standard costs and financial needs with which central government transfers will be commensurate, with the necessary solidarity component, will need to refer to best practices. Each entity will have to balance its budget, net of investment expenditure, as laid down in Article 119 of the Constitution. The total amount of local investment expenditure must be fixed for a multi-year period, in accordance with the objectives for general government net borrowing. Continuing along the lines laid down for the regions with healthcare deficits, the system of constraints and disincentives for non-compliant entities will need to be strengthened. But the budgetary rules are not sufficient to guarantee efficient use of resources. Clear and comparable information is needed on the quality of the services provided by the various entities so that single administrations can locate the weak points in their own systems, citizens can evaluate the performance of administrators, and the State can apply sanctions, including the power to take over the management of entities that fail to guarantee essential service levels. Costs and results vary enormously between entities providing the same services; this indicates that there is substantial scope for improvement. But today we are beginning to get the data needed for evaluation and concrete action. A number of initiatives are moving in this direction. The Ministry of Health has drawn up an experimental set of indicators for healthcare quality, efficiency and appropriateness, both at regional level and for individual hospitals or health units. The Ministry of Education has introduced standardized tests into student evaluations to increase the comparability of the marks awarded and their weight in evaluating teaching effectiveness. The High Council of the Judiciary has identified a methodology to define standard workloads for judges as a tool for assessing their productivity. Tax evasion is a brake on growth because it imposes higher taxes on those who do pay; it reduces the resources for social policies and obstructs interventions in favour of low-income persons. The tax wedge on labour is about 5 points higher than the average for the other euro-area countries; the tax rate on low labour incomes and the corporate tax rate, including the regional tax on productive activities, are 6 points higher. Istat estimates that the shadow economy amounts to 16 per cent of GDP. Comparing national accounts data with tax returns, it can be estimated that between 2005 and 2008 30 per cent of the VAT tax base was evaded: in terms of tax receipts, this is more than €30 billion a year, 2 points of GDP. The Government has introduced measures to combat tax evasion. The immediate objective is to contain the deficit, but in the medium term the reduction of evasion must be a lever for growth by allowing tax rates to be lowered; the connection between the two must be made visible to taxpayers. Corrupt dealing between private agents and general government, in some cases encouraged by organized crime, is widespread. In the international rankings that are compiled periodically, Italy stands further and further down on the list. Empirical studies show that corruption impedes economic growth. There is a close connection between the density of organized crime and the level of development: in the three regions in the South where 75 per cent of Italy’s organized crime is concentrated, per capita value added in the private sector is only 45 per cent of that in the Centre and North. Action to prevent and combat money laundering continues. The Financial Intelligence Unit and the Bank’s Supervision Departments have intensified cooperation with the judicial authorities and the law enforcement forces, especially in cases where there is a close connection with criminal investigations. The crisis has exacerbated the difficulties of young people in the labour market. In the 20–34 age group, the unemployment rate reached 13 per cent on average in 2009. The fall in the employment rate of younger workers with respect to 2008 was almost seven times that of their older counterparts. This was due both to the more widespread use of fixed-term contracts for young people and to a contraction of 20 per cent in new hiring. For some time now, the gap in employment conditions between the new generations and their predecessors has been widening to the disadvantage of the former. Entry-level wages have stagnated for fifteen years in real terms. A slow recovery increases the likelihood of persistent unemployment. This condition, particularly at the start of one’s working life, tends to be linked to permanently lower earnings later on. The reform of the labour market must be completed, overcoming segmentation and stimulating participation. Young people alone cannot cope with the growing burden of an ageing population. Nor will the contribution of foreign workers suffice. Only 36 per cent of Italians aged between 55 and 64 are in employment, against a European average of 46 per cent, and 56 per cent in Germany. In Italy in the last thirty years, against a lengthening of more than five years in life expectancy at age 60, the average age at retirement in the private sector is estimated to have risen by about two years to around 61. Working life will have to be extended, partly to guarantee an adequate standard of living to the older people of tomorrow. The countries in Europe with the highest employment rate in the 55–64 age group are also those with the highest youth employment. In 2009 the Government took an important step by automatically establishing a link, from 2015, between the minimum retirement age and changes in life expectancy; a regulation now being drafted will implement this provision. Actions on the so-called retirement “windows” and on regulations for women employed in the public sector move in the same direction. INPS has launched initiatives to give better information to workers about their personal pension position. The process of pension system reform could be completed by measures that gradually standardize the retirement age among different groups of workers, speed up adjustments to the transformation coefficients of the contributions-based system, and provide greater retirement flexibility. Banks, supervision Lending to firms declined by 3.7 per cent on an annual basis between September and December 2009. In 2010 the pace of the contraction eased and in the three months ending in April came to 1 per cent. The sharpest decline has been in northern Italy, where industrial activity is most intensive; lending to firms in the South has begun to grow again. Credit to households has continued to expand, albeit slowly. Last year’s credit contraction largely reflected the weakness of demand for loans, but there were also supply-side tensions. According to the Eurosystem’s Bank Lending Survey, these gradually eased from mid-2009 onwards. We recently conducted the survey at regional level, expanding the sample; the results indicate improving supply conditions in the early months of this year in the North-West and the South. In Italy, as in other countries, the quality of bank loans deteriorates during recession. In 2009 the loan losses of our five largest banking groups absorbed almost 70 per cent of their operating results; their profits fell by over a fifth. The trend, though moderating in early 2010, has continued and is affecting smaller lenders too, who were less badly hit in the early stages of the crisis. With the onset of the Greek crisis, acute liquidity strains in the interbank market have returned after subsiding last year. Transactions are mostly very short term. There is a large share of collateralized contracts, a tendency to deal with domestic counterparties and frequent recourse to bilateral trades. Banks must be prepared to face recurrent and protracted periods of abnormal market conditions. As more and more public and private issuers have turned to the markets, in 2011 a flurry of bank bonds are due to mature for very large amounts; banks must continue to strengthen their sources of fund-raising, including by making greater use of covered bonds. Although 2009 was a year of reduced profits, Italian banks made encouraging progress in strengthening their capital base. Contributions came from market issues, asset divestments, dividend restraint, and injections of public capital. By March of this year the core tier 1 ratio of the five largest Italian banking groups had risen to 7.6 per cent, from 5.8 per cent at the end of 2008. Our stress tests show that even under adverse scenarios in line with those used in comparable international exercises, such as GDP growth 3 points lower than current estimates in 2010–11, compliance with the minimum regulatory requirements and financial stability would not be at risk in Italy. However, in the face of persistent market volatility and uncertainty over the macroeconomic outlook, capital strengthening must continue. Preparations for the new international standards must be made. The analysis of the overall effects that the new capital and liquidity rules will have on Italian banks is still under way. The parameters must be defined; the specific regulatory provisions will be applied flexibly and with a calendar permitting a smooth and gradual transition. Capital instruments already issued based on the old rules will continue to count towards the requirement for a long time (grandfathering). Supervisory action in Italy has several distinctive features. It does not stop at establishing general prudential principles, leaving their interpretation up to the market. Nor does it limit itself to verifying compliance with the rules. Instead, it weighs intermediaries’ strategies and management; without interfering in business decisions, it verifies that governance, organization, operating processes and control systems are consistent with the risks. Our off-site controls are supplemented by a high level of on-site supervision. In 2009 there were over 200 inspections of banks and other intermediaries. Targeted checks increased substantially. In the largest banking groups the presence of inspectors is continuous and, in cooperation with the other European authorities, is being extended to their cross-border operations. This system of controls, together with particularly prudent regulations, proved vital in preserving banks’ stability during the crisis. The role of foundations as shareholders in banks cannot be other than that established by law: investors whose sole objective resides in the economic value of the investment. The foundations, in their autonomy, will be the first to safeguard the independence of management. Major banks are also judged by how they are organized locally: maintaining and capitalizing on relations with the local economy means basing customer assessments on knowledge accumulated over the years, which is much more reliable than that inferable from quantitative models; it means knowing how to discern a creditworthy firm even when the data are not in its favour; it means knowing your business as a banker. The response of large banks to local needs, consistent with sound and prudent management, must be compatible with global strategies and vision. Thorough supervisory screening of the requirements of officers of banks and other intermediaries is a fundamental instrument of control, a guarantee of stability. So is the possibility of removing those responsible for mismanagement or highly risky conduct before the situation precipitates, necessitating crisis measures against the bank as such. An extension of the Bank of Italy’s supervisory powers in this direction would be welcome; supervisory authorities in major economies already have such powers. The Committee of European Banking Supervisors has proposed it and the European Commission is considering its adoption at Community level. Customer protection is now a supervisory objective in itself. We carefully follow the implementation of our rules on the transparency of banking and financial services and on correctness in relations between intermediaries and customers. The Banking and Financial Arbiter, in operation since October, is an independent body that provides customers with rapid responses in disputes with their bank. The majority of the 560 decisions taken to date – on current account and consumer credit charges, mortgage portability and payment card irregularities – have found in favour of the customers. *** The crisis has reminded us, brutally, of the importance of joint action, common objectives and policies, shared sacrifices. This lesson goes for the world, for Europe and for Italy. The reform of the rules governing finance transcends national borders. It requires consensus among a large number of different jurisdictions. But there is no alternative: a globally integrated financial services industry requires regulation that is universal, at least in its fundamental principles. The harsh experience of the last few years must not be forgotten. Excessive risks exact an extremely high price from the community. Strengthening the defences of the system is indispensable, within each country and at international level. Banking will be less profitable, but also less risky. All will benefit. I am certain that the political project launched by the G20 will succeed. The euro area as a whole is sounder than other currency areas. Public budgets and the external accounts are more balanced. But the attack on it now under way is not directed against the area as a whole. Exploiting the opportunity offered by the unfinished state of the project, it isolates the weakest members. There is but one answer: the euro lives with all its members, large and small, strong and weak. If in the past it was an illusion to think that the currency alone could “make” Europe, today the only course of action is to reinforce the construction of Europe: in the political sphere, with a more active government of the Union; in budgetary discipline and in progress on structural reform, with a new stability and growth pact that is at once broader and more binding. Two years ago I devoted a good part of my concluding remarks to the persistent gap between the North and South of Italy. And it was with that examination that, in practice, the Bank of Italy began the celebration of Italy’s 150 years of national unity. We are convinced that national unity must be honoured by strengthening it, ensuring its vitality and adapting it to a new era. This is not the first time in its history that Italy has been faced with an arduous collective challenge. It has faced and overcome many in the past century and a half. Let me mention two examples. The greatest challenge of all, in terms of structural reforms, arose when Italy, immediately after national unity, prepared to participate in the life of Europe with a population that was 75 per cent illiterate, against 30 per cent in the United Kingdom and 10 per cent in Sweden. National political leaders, administrators, teachers, North and South, joined together to fight the battle for literacy. In the end we did come up to the level of the rest of Europe, and this was one of the factors behind the economic miracle after the Second World War. In 1992 we were confronted with a much more severe budget crisis than those facing some European countries today. The government of the day presented a financial adjustment plan which, enjoying national consensus, gained credibility in the markets with no assistance either from international institutions or from other countries. The struggle was long drawn out: under a flexible exchange rate regime, three years on, spreads still exceeded 650 basis points. Yet the battle was won, because the successive governments maintained fiscal discipline: stability had been incorporated into the country’s political culture. Today’s battle too – to combine fiscal discipline with the return to growth – must be fought by calling on those same values that have enabled us, together, to vanquish the difficulties of the past: the capacity to act, equity; the desire to know, solidarity. Let us take up this challenge in the awareness of the weaknesses that we must overcome but also of the considerable strengths on which we can draw. | bank of italy | 2,010 | 6 |
Special address by Mr Ignazio Visco, Deputy Director General of the Bank of Italy, to the OECD-Bank of Italy Symposium on Financial Literacy, "Improving financial education efficiency", Rome, 9 June 2010. | Ignazio Visco: Financial education in the aftermath of the financial crisis Special address by Mr Ignazio Visco, Deputy Director General of the Bank of Italy, to the OECD-Bank of Italy Symposium on Financial Literacy, “Improving financial education efficiency”, Rome, 9 June 2010. * 1. * * Introduction The financial crisis and its roots have been widely analysed. The crisis arose out of the interaction of financial innovation, information asymmetries, regulatory failures and lax supervision with macroeconomic conditions characterised by low interest rates, asset-price misalignments, and large saving-investment imbalances. These factors prompted the financial sector to take large and poorly understood risks, to raise leverage to disproportionate levels, and to rely increasingly on wholesale short-term funding, thus creating further sources of contagion. The crisis has shown us just how severe the unintended consequences of complexity can be. It has also revealed that many households and investors are unaware or only partially aware of the implications of many of the financial decisions they take. The credit boom that preceded the crisis, particularly in the United States, was fostered by overconfidence in everincreasing home values and asset prices and persistently low interest rates. Overconfidence is usually present in credit booms and asset price bubbles. This time, however, the scope and depth of the crisis have been exceptional because the financial system’s role in our economies has become so much larger than in the past. As a result of the crisis, the financial system’s ability to channel savings to the most productive investments and to assist in the inter-temporal allocation of resources has been substantially damaged. At the same time, confidence in the support it provides to risk diversification and portfolio management has been shattered. Restoring confidence and ensuring the long-run sustainability of financial flows is now paramount. In response to the crisis, prudential regulation for banks through higher capital requirements is being tightened and new standards to contain liquidity risk are being introduced. Consultation and cooperation among national authorities are being reinforced and new forms of international coordination are being envisaged for crisis management and resolution. These measures are aimed at increasing the stability of the financial system as a whole. Attention is also being paid to the structure of incentives within financial firms and to the way business is conducted. Risks must be correctly evaluated and presented. A regulatory framework designed to ensure consumer protection and fair relations between financial intermediaries and their customers is necessary to limit conflicts of interest and is a prerequisite for customer confidence. However, within an appropriate system of incentives and sanctions to regulate the conduct of intermediaries, financial responsibility ultimately rests with individuals. This is why we must invest in financial education, to improve the way financial decisions are taken and to raise awareness of the risks inherent in financial assets and liabilities. In the past households had fewer financial decisions to take and the choice of investments and debt instruments was more limited. Pension systems were mostly publicly funded, mortgage markets were less developed, consumption more tied to current income streams. As the financial system has grown more diversified and complex, households have enjoyed a broader set of opportunities while potentially facing substantial new risks. Furthermore, because of demographic changes and the tighter constraints on public finances, our welfare and that of our children are more likely to depend on financial decisions at the individual level. Education, healthcare, retirement living standards will depend heavily on sound financial planning. At the same time, financial literacy is a key ingredient of competitive financial markets. Competition in the financial industry requires not only a multiplicity of suppliers to choose among, but also that consumers be properly informed when making their choices. Obstacles and difficulties in gathering and processing information increase switching costs. Informed and financially literate consumers are essential to the effectiveness of price and quality competition. 2. Financial education and customer protection Consumer protection is pursued with regulations on transparency and conduct of business. These are essential in a relationship between customers and intermediaries where unavoidable information asymmetries make it impossible for the investor to monitor independently the work of the intermediary. In addition, deregulation of financial markets and the reduction in costs brought about by developments in information technology have resulted in a proliferation of new products; the pace of financial innovation is so fast that investors are faced with products with too short a history to make reliable estimates of the probability of returns. They must be made aware of this. Customer protection promotes confidence in the enforceability of contracts, an essential ingredient for financial intermediation. Properly enforced consumer protection prevents intermediaries from adopting reprehensible practices and enhances competition based on prices, quality of services and product innovation. Appropriate regulation on the conduct of business makes it easier for customers to react to malpractices earlier and regardless of sanctions imposed by supervisory authorities. While rules on transparency and the conduct of business have typically a top-down design, financial education can be held to protect confidence, stability and competition in a bottom-up perspective. Indeed, supervisory authorities are tackling the financial education issue as an important element in the wider context of their responsibilities. As the OECD put it in its 2005 report on Improving Financial Literacy, “financial education provides policymakers with another tool for promoting economic growth, confidence, and stability”. Financial education helps investors to monitor intermediaries. Households better acquainted with the notions of risk and return, compound interest and inflation can better identify abuse and fraud as well as understand the real terms of what they are being offered. There are many recent examples where the placement of financial instruments has been largely based on poor understanding of the fact that unusual earnings can be offered only against unusual risks and in ways not necessarily consistent with the risk aversion, financial situation and investment objectives of many investors. For reputational concerns to play a role in checking the behaviour of financial intermediaries, investors must be able to compare different financial products and assess the quality of the services provided by different institutions. Financial education can therefore complement the supervisory action of the authorities in fostering enhanced competition. Finally, financially literate households are less likely to believe that they have been cheated when that was not the case. Thus, financial education helps to sustain confidence in the financial system and can have a beneficial effect on the stability of intermediaries by reducing their legal and reputational risks. Indeed, the financial industry is likely to benefit from having more literate customers. For all its merits, however, financial education should not be regarded as a silver bullet by any of the interested parties (consumers, regulators, industry). First, knowledge takes time to build. Second, evidence on the effectiveness of financial education in improving financial behaviour is mixed, and clearly depends on the kind of programmes provided. Third, we should not expect financially literate consumers never to make mistakes: the financial sophistication of the people fooled by Bernie Madoff, and their numbers, are a sober reminder that financial education does not provide foolproof protection against fraud. Indeed, it might even, to some extent, induce overconfidence. But, all said, investing in financial education still seems the safest bet if we want to improve individuals’ ability to take advantage of the opportunities offered by the financial system. 3. Promoting financial education The Italian public debt, currently running at around 115 per cent of GDP, is high by international standards. It is well known that most of the growth in public debt took place during the 1980s, when large budgetary deficits piled up and disinflation was slow and incomplete; this eventually led to the financial crisis of 1992–1993. Afterwards, in the run-up to the economic and monetary union (EMU), substantial stability was restored as public debt was progressively reduced from a peak of over 125 per cent of GDP in 1995 to about 105 per cent in 2007. This was largely the result of two factors: the reduction in interest payments and the rise in revenues from privatization programmes. The fall in interest rates reflected not only the taming of inflation but also the reduction in “sovereign risk”. It is also well known that Italian households used to have high saving rates, while it is less well known that their levels of debt, and in general those of the whole of the private sector, have always been relatively low by international standards. The high saving has meant that interest earnings have been an important component of households’ disposable income. However, when interest rates were reduced in the second half of the 1990s, the income share of net interest flows fell from an average of about 12 per cent in 1992–1996 to 8 per cent in 1999–2001. The negative trend continued over the initial years of the EMU, reaching a low of around 6 per cent in 2005. Two main factors have been at work: the progressive reduction of government bond yields and the reallocation of households’ portfolios from relatively “safe” to riskier assets. This process was particularly in evidence in the second half of the 1990s, as government bonds held by households contracted from about 21 per cent of total gross financial wealth in 1995 to 12 per cent in 1999. After a partial recovery at the beginning of the new decade (in connection with the stock market crash of 2001), the share of government bonds over total financial assets fell below 10 per cent. According to the Bank of Italy’s Survey on Italian Households’ Income and Wealth (SHIW), the portfolio shift out of government bonds was widespread across different groups of investors. The proportion of households with low education (at or below lower secondary school level) holding government bonds fell from 49 per cent in 1995 to 23 per cent in 2000 and 15 per cent in 2004; it increased slightly in the following years (up to 20 per cent in the 2008 survey). At the same time, the share of low-education households investing in risky assets increased from 15 per cent in the mid-1990s to 32 per cent at the turn of the century, averaging around 25 per cent since then. This most likely reflected the attempt to compensate for the fall in government bond yields caused by the reduction in inflation and in real rates without being fully aware of the higher risks involved; a stunning example of this was the massive investment in Argentinean bonds by Italian households. To the extent that education proxies financial literacy, these trends may raise concerns about households’ ability to manage the higher risk in their financial portfolios, especially as financial innovation deepens and increasingly complex financial tools become available. Indeed, in Italy, levels of financial literacy still appear to be low. As the SHIW has shown, about one third of the population is unable to read a bank statement, calculate changes in purchasing power, distinguish between different types of mortgage and evaluate the associated interest rate risk. More than half of Italian households do not understand the importance of investment diversification, and two thirds do not know the difference between shares and bonds in terms of risk. Less than one household out of three knows the main features of supplementary pension schemes. Although it may be difficult to make generalisations on financial literacy at the international level, findings like these seem to be common to several countries. They show that there is little knowledge of basic financial concepts and low computational and statistical skills. A couple of examples will suffice. According to surveys conducted in the United Kingdom, households’ ability to plan ahead seems to be fairly poor. More than 80 per cent of the pre-retired think that a state pension will not provide them with the standard of living they hope for in retirement. Nevertheless, only slightly more than half of them have made some additional pension provision. Also, 70 per cent of the population have made no personal provision to cover an unexpected drop in income. Households also expend little effort in choosing products. For example, one out of two holders of saving accounts is unaware of the current interest rate. One out of ten holders of credit cards simply use them because they came with their bank account, and only half of credit card users choose their credit card on the basis of the interest rate charged on it. One out of three of those who have only general insurance bought their policy without comparing it with even one other product. The latest survey conducted in high schools and colleges in the US by the Jump$tart coalition shows that more than 50 per cent of high school students do not correctly understand how to manage their credit card debts or choose the repayment rates; only 17 per cent are able to appreciate the different returns of stocks, savings bonds, savings accounts and checking accounts; 60 per cent are not familiar with their health insurance coverage; 36 per cent are unaware of the impact of inflation on savings. Poor knowledge and skills may have serious medium-to-long term consequences for the well-being of households. Financial literacy programmes might help. However, given that the competences required depend on people’s needs at a certain moment in their life, a onesize-fits-all approach to improving the skills of the entire population, from students to retired people, is not feasible. This means that priorities need to be clearly set, in terms of targets and goals. Financial education programmes could be targeted to leveraged households and to the very poor, who have the most to lose if they make bad decisions; to students, who will be the consumers of the future. The OECD has identified two priorities. First, education in schools: younger generations are likely to bear increasing financial risks; schools are regarded as an efficient and fair way of reaching an entire generation nationwide and putting all young people in the same age group on an equal footing. Retirement-saving literacy programmes addressed to the labour force are also a priority. In fact, several countries are shifting towards a more or less compulsory system of private savings accounts. Thus, as pointed out in a 2005 G10 report on Ageing and Pension System Reform, also published by the OECD, one of the policy challenges for these countries is to develop financial education programmes that “can help consumers avoid abuse and fraud, improve their investment choices, and raise their contributions to private pension plans”. Once the target has been determined, it is necessary to identify the skills that should be acquired with the programme. Especially important in this respect is the recognition that not only are levels of financial education generally low, but so is awareness of the need for it. Closer investigation of the causal connections between different programmes of financial education and investment decisions is still needed and more effort must be put into identifying those forms of financial education that more effectively improve financial behaviour. As a further caveat, it should be remembered that the financial industry evolves quickly. It is therefore better to focus on general principles rather than on detailed information about specific products. The provision of information, however important, cannot always fully protect unsophisticated consumers. Even when, as regulators rightly require, the information disclosed to the public is not deceitful or manipulative, an information overflow might generate confusion and ultimately hamper customers’ decision making. Indeed, financial education programmes developed as a mere delivery of information may fail to reach the expected goal. The limited available evidence seems to suggest that education strategies are most effective if those trained are actively involved and experience effective gains and losses from simulated decisions. It is worth emphasising again that the success of financial education programmes largely depends on people’s awareness of their level of financial literacy and of the enormous impact this will have on their medium-to-long term well-being. People who are aware that their level of financial literacy is low may be more receptive to educational programmes and proactively strive to acquire the information and knowledge they need. Financial educators should use mass media and effective communication strategies to develop such awareness. Knowledge of the costs associated with short-sighted financial decisions is also very important. Consumers are used to shopping around for relatively sophisticated goods or for important investments (such as in real estate). In fact, the cost of not doing so is evident to them. Customers need to be encouraged to shop around even for banking and financial products and services. 4. The Bank of Italy’s financial education initiatives In Italy, financial education has only recently entered the limelight. As one of the first institutions to point out the importance of this issue to the country, the Bank of Italy has, on several occasions, stressed the need for investors to acquire appropriate and up-to-date financial education as one of the key components of comprehensive action to foster economic and business growth. Since then several initiatives have been launched. In the last two editions of the Bank’s SHIW (for 2006 and 2008) specific questions were included to measure the financial literacy of the Italian population (ability to read a bank statement, calculate variations in purchasing power, measure bond yields, calculate accrued interest, understand the relations between the various securities and distinguish between types of mortgage loan). As mentioned before, the findings were in line with those of other advanced countries and confirm the need for financial education programmes: about 50 per cent of Italian households do not possess the basic knowledge required to make informed decisions on the most common financial transactions. Since 2007, the Bank of Italy’s website contains a section dedicated to financial education. It attempts to provide easily understandable information on the main banking products as well as clear explanations of banking, economic and financial matters. In the near future it will be made more interactive and attractive to the public. Young people, students in particular, are a priority target of the Bank of Italy’s financial education programmes. Based on a Memorandum of Understanding with the Ministry of Education signed in November 2007, an experimental project to incorporate financial education into school curricula was launched in 2008. This initiative, inspired by international principles and best practices, is the first project in Italy to be launched by public authorities in this field and specifically addressed to students. Experts from the Ministry of Education and the Bank of Italy jointly prepared lessons on money and payment instruments to be delivered in schools. The first wave of the programme took place in the 2008–2009 school year and involved a limited number of primary, lower secondary and secondary schools in northern, central and southern Italy. The effectiveness of the educational programme was measured by means of tests administered to students before and after lessons were delivered. Students who had not received any financial training were also given the tests to serve as a reference sample. The tests were developed in cooperation with INVALSI, the National Institute for Assessment of the Efficiency of the Educational System. The results showed that the educational programme was effective in improving students’ familiarity with money and alternative payment systems (the percentage of correct answers rose from 81 to 89 per cent in primary schools, from 70 to 76 in lower secondary schools and from 60 to 69 per cent in secondary schools). Those results led the Bank of Italy and the Ministry of Education to extend the project to the current school year and involve up to 250 schools and 8,500 students nationwide. The test results confirm, on a larger scale, the efficacy of the educational programme. Measuring the impact of financial education programmes is no easy task, however. There are technical challenges, as the adoption of a rigorous experimental protocol can be difficult in a school environment, where the standardization of treatment clashes with the discretion teachers need to maintain, risks of contamination are high and ethical problems can be strong. More fundamentally, the impact on financial behaviour, which is the ultimate goal, cannot be measured straightforwardly, since students may still be years away from important financial decisions. To address some of these difficulties, a new programme will be launched next year, specifically designed to verify whether financial education improves the ability to take advantage of the opportunities offered by the financial system (borrowing, retirement saving, taking out an insurance policy, investing savings). The programme adopts an experimental protocol “treating” secondary school students: they will be given, in a standardized way, some notions on the role of the financial system, on sound decision making, on the identification, impact and assessment of risks and returns. Before and after the treatment, both the treated students and a control sample will be involved in simulated problems, mimicking the main features of actual financial decisions. The objective is to gauge, through the changes in the quality of the decisions observed, the effectiveness of financial education. While providing financial education initiatives, policymakers could and should cooperate with other parties, in particular consumer and industry associations. The Bank of Italy is cooperating with the other supervisors and regulators, such as Consob, Isvap, Covip, AGCM, which are all represented here today, to define a coordinated national strategy. A single financial education web portal will be developed to pool all the educational material and tools already present in the websites of the individual supervisory authorities. 5. Conclusions It is unlikely that a higher degree of financial literacy worldwide would have significantly helped to contain the financial crisis. And it is also unlikely that complex financial decisions could be made by each person becoming their own personal financial adviser. We must use regulation and supervision to make the financial system more resilient to shocks and to enhance efficiency in a more competitive and also a more stable environment. Substantial changes are needed, and they need to be introduced through a cooperative and coordinated international process. Most likely they will imply less risk-taking and possibly lower returns for the financial industry, but also for its customers. The latter, however, is already a significant reason why investing in financial education is important. Some of the non-negligible effects of the crisis could in fact be a substantial loss of trust in the financial industry; a reluctance to take fundamental and conscious decisions related to saving for retirement; for some people, discouragement from exploiting even the safest, though not risk-free, investment opportunities, while for others a renewed search for high yields in a world of diminished returns without understanding the higher risks attached; for most, a wariness concerning the use of debt. Thus, while not a panacea, investing in financial education is an important means to perform our institutional duties: protecting savings, ensuring stability and promoting competition. In Italy, the fact that financial education programmes are just beginning to see the light can offer the opportunity to build sound future initiatives on the basis of international best practices. We have to identify the financial education needs of the population, develop the necessary framework, and share responsibilities among the various stakeholders. Financial literacy requirements should be identified in a national perspective. Nonetheless, as this Symposium shows, developing common strategies and sharing information and experience at the international level is essential for satisfactory achievements. | bank of italy | 2,010 | 6 |
Concluding Remarks by Ms Anna Maria Tarantola, Deputy Director General of the Bank of Italy, at the OECD-Bank of Italy Symposium On Financial Literacy, Rome, 9 June 2010, Session: 17:30-18:00. | Anna Maria Tarantola: Financial literacy Concluding Remarks by Ms Anna Maria Tarantola, Deputy Director General of the Bank of Italy, at the OECD-Bank of Italy Symposium On Financial Literacy, Rome, 9 June 2010, Session: 17:30–18:00. * * * Today more than ever, citizens need to be financially aware, to know the characteristics and risks of financial products, to choose correctly. It is a matter of equity, it is a need for stability, a help for competition. However, the surveys conducted worldwide to measure population financial literacy are discouraging; this is also true for Italy. In Italy a quarter of the population ignores basic financial notions, 50% is not familiar with diversification, about 30% cannot tell the difference between stocks and bonds. There is little awareness of the importance of supplementary pension schemes. As surveys show, people are not aware of their financial illiteracy and poor skills. Seminars like the present one are very useful to find out the dimension and the heterogeneity of the problem, the actions that have to be taken. Banking and financial customers protection is necessary but not sufficient. That’s why we need to launch specific initiative to promote financial education in all countries in a proper, coordinated manner. As emerged in the discussion, many actors can play a significant role depending on their institutional mission: Governments, Supervisory authorities, as the OECD has recommended since 2005, private stakeholders. Governments and even private stakeholders should provide resources; the amount of resources is a critical requirement for success. Supervisory authorities could play a significant role in implementing the actions undertaken. Bank of Italy, in coordination with the Ministry of Education, is developing a project to introduce financial education in the school curricula in a systematic way. The plurality of players requires collaboration and coordination to develop a common strategy, avoid duplications and ensure that all issues are properly dealt with consistently. Actions have to be evidence based: Panel I dealt with this issue. Financial education should be tailored to citizens’ specific needs. Needless to say, young people and retired people have very different financial decisions to take. A key step in delivering financial education is the evaluation of its impact and effectiveness. It is not a simple exercise; it requires the assessment of the changes of individuals’ behaviour. But the causal connection that binds knowledge, skills and behaviour cannot be taken for granted, despite their correlation. As Panel II speakers told us, some information on that issue can be provided by behavioural economics. Individuals do not act as rational agents: they recall information selectively, make little use of statistical analysis, have unstable preferences, have cognitive and emotional limitations, are vulnerable to social pressures. These circumstances have testable implications on decision-making and choice, and should be taken into account when programs are aimed at changing people’s behaviour. Over-reliance on information alone must be prevented. It is necessary to balance the possible approaches, provide clear and accessible information, provide also cognitive instruments to correctly process information and make the appropriate decisions, encourage familiarity with financial issues. Knowledge, behaviour and attitudes are the three pillars of any sound programme. We have to avoid that financial education increases confidence without increasing skills: the risk is overconfidence that contributes to sub-optimal decisions. Good communication is also essential for successful programmes. The language must be consistent with the target group and the goals of the programme. Especially when programmes are addressed to the most vulnerable and least educated groups of the population, the language must be clear and easily understandable. Panel III was dedicated to one of the areas where the need for financial education programmes is most compelling: pension schemes. In the face of demographic trends people need to understand the risk of poverty in retiring age and to take the proper, counterbalancing actions. In this field, there seems to be a link between general knowledge of financial matters, familiarity with the public pension system and participation in supplementary pension schemes. For this reason we are confident that education can promote virtuous behaviours. Speakers have pointed out some strategies to promote pension literacy: – provide clear and understandable information on pension schemes; – deliver financial education at school in order to increase youth awareness that rainy days can come. Financial education may benefit individual citizens and the system as a whole; it promotes a more competitive market of financial products and services; it empowers customers vis-à-vis the financial industry. As I have already mentioned, Bank of Italy has launched some initiatives, but this is just the beginning. I am glad to announce that Italian supervisory authorities have decided to combine their efforts, enhance their mutual cooperation mechanisms and coordinate future financial education programmes. Today a Memorandum of Understanding on mutual cooperation in the field of financial education has been signed. In the framework of this agreement, and in line with the experience of other Countries, the supervisory authorities are developing a common web portal as a clearinghouse of the existing information materials. I wish to close this Symposium by thanking all participants for their very valuable contribution in promoting financial education. I particularly wish to thank Mr Boucher, it is a great honour, Richard, to have you here at the Bank of Italy. Thank you, for letting us host this important symposium. | bank of italy | 2,010 | 6 |
Opening remarks by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the 2nd EFIGE (European Firms in the Global Economy) Scientific Workshop and Policy Conference, Rome, 18 June 2010. | Mario Draghi: Trade, competitiveness and Europe Opening remarks by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the 2nd EFIGE (European Firms in the Global Economy) Scientific Workshop and Policy Conference, Rome, 18 June 2010. * * * It is a honour and a pleasure for the Bank of Italy to host the second EFIGE Scientific Workshop and Policy Conference. EFIGE stands for “European Firms in the Global Economy: Internal Policies for External Competitiveness”, and no topic could be more relevant for the policy debate today: we are in the aftermath of a global recession that may have redesigned the comparative advantages of nations; that is challenging the capacity of most European economies to maintain competitiveness. Foreign trade has been one of the main channels of contagion in the global crisis since 2008. The case of Italy is emblematic. Despite a financial structure with many strong points, from the stability of the banking system to the financial health of households and firms, Italy suffered greatly the international crisis. In 2009 Italy’s GDP contracted by 5 per cent, more than the whole euro area, more than in any other time since World War II. Despite some recovery since the second half of 2009, industrial production is still one fifth below the cyclical peak recorded in the spring of 2008. The survey of Italian firms that the Bank of Italy conducts every year has allowed us to unveil the mechanisms through which the crisis propagated within the productive system. The large and sudden fall of demand in international markets led exporting firms to sharply cut back production, investment and purchases. These direct cutbacks have spread over through the supply chain: larger firms could offload a good part of the non-diversifiable risk due to the fall in demand on small suppliers. This effect was possibly amplified by relocations and re-internalizations of some production activities. Hence the crisis also hit firms less open to foreign trade. More broadly, the increasingly widespread international supply chains have contributed to the universal reach of the crisis, compounding the effects of distressed financial markets. It has been a big shock. Looking ahead, the point is now to understand to what extent trade flows and the geographical patterns of global production networks have been reshaped by the crisis. How has the position of individual firms and countries changed? What can the impact be of the necessary unwinding of global imbalances in the years to come? In 2008 and 2009 several countries undertook trade-defensive measures, in particular imposing discriminatory anti-dumping duties specifically targeted against low-cost exporters, such as China. In a number of cases, developing countries have also introduced new tariff and non-tariff barriers; advanced countries have instead often turned to measures in support of the domestic sector (such as the bail-out of specific domestic industries or economic stimulus packages incorporating discriminatory clauses), with potential indirect anti-trade effects. More importantly, lack of effective political support has continued to delay the conclusion of the WTO Doha Round. Protectionism remains the wrong answer, all the more at the present juncture. Trade is a powerful engine of growth. It helps break down local monopolies, reduce prices to the benefit of consumers and firms. International competition favours productivity improvements through the reallocation of resources from less to more efficient firms and by spurring firms to innovate. This takes us to the second keyword of the EFIGE project: competitiveness. In a monetary union the lack of competitiveness causes stagnation, unemployment, and, in the long run, budgetary strains. The new European Strategy, “EU2020”, sees in competition, human capital, innovation and R&D the crucial growth-enhancing factors. These factors also interact with firm productivity and size to determine a firm’s success on international markets. In the manufacturing sectors more severely hit by the crisis, the most resilient firms have been those that have been capable of shifting their sales to the most dynamic emerging markets, and those with a high degree of market power warranted by their ability to innovate and satisfy their customers’ needs. The EFIGE project has a third important facet which is worth mentioning: its European perspective. In Europe, common cultural and historical roots, common goals and policy frameworks live together with a pervasive national heterogeneity. The diversity ranges from institutional architectures to political decision-making, to economic agents’ choices and patterns of behaviour. For analysts, this is a resource: they can compare countries and firms located in different countries to isolate the relevant differences, to learn from such differences, to identify the best practices. For policy makers it is a difficult challenge. We must reinforce the construction of Europe: the difficult times some European countries have had this year in coping with competitiveness and fiscal crises prove that beyond any doubt. We definitely need a stricter and more coordinated budgetary discipline, but what we need above all is progress on structural reforms in order to enhance growth potential, within a renewed European Pact. That should be our ambition. | bank of italy | 2,010 | 6 |
Address by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the Italian Banking Association Annual Meeting, Rome, 15 July 2010. | Mario Draghi: Economic overview and banking supervision reforms Address by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the Italian Banking Association Annual Meeting, Rome, 15 July 2010. * * * In the life of the Italian Banking Association (ABI), today’s gathering marks the handing over of the baton to a new President. To Corrado Faissola, I would like to convey my personal appreciation, and that of the Bank of Italy as a whole, for his competent, level-headed and decisive leadership of ABI through one of the most difficult periods in the history of economies and financial systems. To Giuseppe Mussari, I wish success in his new undertaking. He will accompany our banking system during a phase fraught with perils but also offering excellent opportunities for a financial system that is able to interpret and serve the real needs of households and firms. The state of the world’s economies The global economic recovery is uneven and of uncertain resilience but it is going ahead. The International Monetary Fund estimates growth in global output at around 4.5 per cent this year and next: 8 or 10 per cent in some large emerging economies and scarcely 1 per cent in the euro area. Here in Europe the recovery, driven by the expansion of world trade, remains exposed to risks: the persistent weakness of domestic demand in our countries; turmoil in still-fragile financial markets that overreact to the heightened perception of sovereign risks; and possible inflationary pressures in the emerging countries, which would lead to more restrictive policies. The Italian economy is now benefiting from the renewed vivacity of world trade. The Bank of Italy’s Economic Bulletin, published today, presents a scenario in which the volume of exports expands by 9 per cent this year and 5 per cent in 2011. Consumption and investment will remain weak because real incomes are stagnant and employment prospects uncertain. Economic policy bottlenecks The consequences of all nations’ economic policies are ever more interwoven and interdependent. An acceleration in the adjustment of imbalances in the public finances is indispensable; the effect on the economic recovery will be positive if the adjustment helps to reduce yields on sovereign debt, which often constitute banks’ benchmark in determining the cost of credit. But if the cloud of uncertainty hanging over bank balance sheets is not removed, funding difficulties will persist. Monetary policy in the euro area remains strongly expansive. The Governing Council of the ECB has continued to satisfy the entire demand for liquidity. Inflation expectations, by contrast with some other countries, are firmly anchored. This fact must not be forgotten: it is the credibility built up by the ECB over the years that has enabled monetary policymakers to exploit the full scope for flexibility in dealing with the crisis. The Securities Markets Programme for the purchase of the securities of euro-area countries under financial pressure injected liquidity into markets in a state of crisis, averting the collapse of the European financial system and preserving the monetary policy transmission mechanism. The resolute commitment to sterilize the liquidity so created remains. Once the solidity of the economic recovery is confirmed, the phasing out of unconventional monetary measures will need to be resumed. Although temporarily suspended in recent weeks because of the severe strains originating in the Greek government securities market, this process has been under way since the end of 2009. No twelve-month refinancing operations have been offered in 2010. The operation that resulted in the unprecedented liquidity injection of over €400 billion a year ago reached maturity on 1 July. In the auctions held in the past two weeks banks requested far less than the amounts maturing, resulting in a significant reduction of excess liquidity. Because some banks are still having difficulty in accessing market funding, this has translated into a moderate rise in money market rates of about 10 basis points. The monetary policy stance must not be altered by the condition of these marginal intermediaries. Their problems need to be dealt with by the relevant national authorities using appropriate instruments. In Italy, a three-year budgetary adjustment package was approved in late May – ahead of the usual schedule in view of the financial market tensions provoked by the Greek crisis. The measures are designed to reduce net borrowing by €12 billion in 2011 and €25 billion in both 2012 and 2013. Two thirds of the adjustment is to come from reductions in expenditure, above all current expenditure. On the revenue side, the measures focus mainly on combating tax evasion. Notwithstanding the short-run costs of the budgetary adjustment in terms of economic growth, prompt action was unavoidable: the projected scenario was not sustainable. We are still paying the price of the slowness with which Italy’s public debt-to-GDP ratio was reduced in the decade following the inception of the European monetary union. Whether the adjustment measures will effectively succeed in attaining the net borrowing objectives can only be determined in the course of the next few months, taking account among other things of macroeconomic developments and their feedback impact on the public accounts. The estimated revenue effects of the measures to curb tax evasion are subject to uncertainty, both upside and downside. Curbing expenditure growth will necessitate a sharp change of course with respect to the tendencies of the past decade. The limits on the resources at the disposal of central and local government will require, if service cuts are to be avoided, a serious overhaul of organization and territorial coverage. Trade payables of government bodies and their public service firms must not be allowed to serve as an instrument for circumventing budget constraints. Public financial adjustment and economic growth, together, are essential conditions for financial stability, which is in turn the pilaster of sustained growth. The indispensable modification of the overall composition of the public budget must be directed to stimulating growth. The reforms under way in the public administration and those that will raise the retirement age move in this direction. The curtailment of tax evasion can be a major factor for growth if it corresponds to the lowering of the rates levied on honest taxpayers. With the economic upswing, global payments disequilibria will tend to widen once more, heightening the connected risks to the sustainable growth of the world economy. The International Monetary Fund is fully committed to ensuring macroeconomic stability, but these imbalances, in being for more than a decade now, will persist for an extended period, and they will have to be funded. This is a titanic enterprise in both size and duration, and one that will only be feasible – without growth-threatening tempests – with capital markets that are far more robust, more transparent and better regulated than in the past. Reform of the rules of finance The recent G20 Summit in Toronto observed that the agenda of essential regulatory reforms is proceeding on schedule. Some aspects of the Summit’s final Declaration deserve special emphasis. First, the importance attached to the reform of Basel 2 in order to increase the solidity of the system, including ambitious requirements on banks’ capital levels and the definitions of capital. Second, the affirmation of the need for further intensification of supervision, the extension of regulation to the shadow banking system, and the reinforcement of the derivatives market infrastructure. Third, the resolution to reach an agreement at the time of the next Summit in November. The new prudential rules will significantly increase banks’ capital and improve its quality, limit financial leverage, contain liquidity risk and attenuate the procylicality of intermediation. Capital will have to comprise resources that can effectively absorb loses; its level will be set by assessing its capacity to deal with stress situations similar to those observed during the crisis. Deductions from capital will be harmonized and applied to core capital. Banks with more capital and less risk will have lower probability of default; they will be able to fund themselves on the market at lower rates and reduce the cost of credit for customers. In addressing the concern that the reforms could slow down the economic recovery, the G20 chose not to lessen their scale but instead to carefully evaluate the timeframe for their implementation. Taking account of the initial conditions of financial institutions in the different countries, adaptation may proceed at a faster or slower pace, but it must be completed by the end of the transition period, whose length is the subject of negotiations at the Basel Committee meeting that concludes today. A crisis management and resolution system built on a sure, agreed legal foundation is essential to an approach that can reduce systemic risk and thus the moral hazard generated by large banks. Generally speaking, then, the orderly management of a crisis requires access to sources of financing. In the first place, resources must be procured by capital writedowns, the sale of assets and the reduction of exposures to unsecured creditors. This can be followed by recapitalization through the conversion of debt into equity. These methods can be usefully supplemented by a deposit insurance system or crisis resolution fund, which should be privately financed, pre-funded, and subject to very stringent conditions for utilization. The introduction of additional prudential requirements and more incisive supervision of systemic institutions can help to limit the build-up of risks; in some countries structural constraints are also being considered. To avoid the propagation of situations of instability, market infrastructure must be designed so as to reduce the possibility of contagion, and derivatives transactions must be brought back into the regulated markets. The specific instruments will necessarily differ from country to country, given the variety of financial systems, but suitable, shared criteria for evaluating the different measures will ensure their efficacy and guarantee a level playing field internationally. The Financial Stability Board (FSB) will draft a first report on these issues for the next G20 Summit in Seoul. But even the best rules are useless if their implementation is not full, if supervisors’ powers are limited. Countries will submit to peer reviews of their supervisory standards, coordinated by the FSB. The impact of the new Basel rules on Italian banks The Bank of Italy’s selective standards for admitting hybrid instruments in the calculation of regulatory capital have been reflected in the comparatively high quality of Italian banks’ capital, which should facilitate their adaptation to the new, stricter Basel standards. The instruments already issued based on the current rules will nonetheless continue to be eligible for a sufficiently long period. The level of attention paid to the quality of capital must be raised further. We have already invited banks to refrain from issuing instruments that will no longer be recognized under the new standards. Since the Italian banking system remains anchored to the core business of traditional lending, the tougher capital requirements for trading and the introduction of financial leverage caps will have a lesser impact than in other countries. The various proposals to deduct deferred tax assets from regulatory capital are likely to have greater effects. Their value is high in Italy owing to uncommonly severe constraints on the tax deductibility of loan loss provisions. If it is deemed appropriate in order to avoid the further penalization of Italian banks, Parliament might consider eliminating the limits on the deductibility of loan losses in favour of a tax that is equivalent in terms of revenue but has a less distortionary impact. The crisis has demonstrated that rules on liquidity are also indispensable. We have already urged banks to prepare for the new standards. European supervision The reform of the European supervisory architecture envisages: a new macroprudential supervisory body, the European Systemic Risk Board (ESRB), entrusted with the prompt identification of vulnerabilities and risks to financial stability and with recommending policies for containing them, and three sectoral supervisory authorities assigned to apply the rules and institute common supervisory practices. Beyond the rules, uniform and incisive controls are also essential. When one national supervisory authority adopts a lax approach, a dangerous breach is opened, through which potential vulnerabilities may be quickly propagated to other systems. Supervisory models and methods continue to display marked differences across countries: in data availability, in the use of on-site and off-site controls, and in the instruments for intervention. Convergence must be ensured by capitalizing on the experience of the countries that have withstood the crisis best. The European Parliament is rightly pushing for the supranational authorities to be endowed with the requisite powers of coordination. A leading role within the ESRB must be secured for the ECB and the national central banks: this would boost the Board’s technical capabilities, fully exploiting the synergies between monetary policy and macro-prudential policy. Stress testing of banks’ balance sheets In the spring of last year, the stress tests at the major US banks revealed, under the responsibility of the prudential authorities that had conducted them, the scale of the risks of individual banks, above all those in connection with the “toxic” assets on their balance sheets. This transparency drive was amply repaid by the markets: these banks, several of which had been assisted initially by public money, succeeded in raising over $200 billion in private capital, an unthinkable figure prior to the publication of the test results. Stock exchange assessments and fund-raising also benefited from the release of the results. Now Europe, albeit in less severe market conditions, has decided to proceed down the same road and will confront the US exercise. But the European tests examine more risk factors than those contemplated in the American case. In addition to adverse macroeconomic conditions, they also assume an increase in the market’s perception of sovereign risk. The stress test hypothesizes: GDP growth three percentage points lower than that currently estimated by the European Commission for the two years 2010–11; and a larger rise in medium- and long-term interest rates than that recorded during the Greek crisis in the early days of May of this year. Compared with the US exercise, which involved 19 banks and three supervisory authorities, the European stress testing is much more complex, involving 91 banks in 20 countries. It is being carried out by national supervisory authorities in accordance with common guidelines and coordinated by the Committee of European Banking Supervisors with the participation of the ECB. The effort made by the authorities and the banks themselves has been exceptional. We hope that communications will be marked by a high degree of transparency. The results of the tests will be published on 23 July. By that date European governments will need to be ready to adopt appropriate measures if the results point to capital weaknesses and market solutions are not available. The Italian banks The tests on the Italian banks participating will inevitably produce a range of different results, but I am confident they will show individual banks’ capital to be adequate. In the first quarter of this year the ratio of new bad debts to total bank lending remained stable at 2 per cent, a high value by comparison with the last ten years. We expect the flow of new bad debts to remain substantial in the coming months. The conditions of the markets and the economy continue to impinge on banks’ profitability. The low interest rates compress the margins on traditional banking business. In the first quarter the operating profit of the five largest Italian banking groups was the same as in the first quarter of 2009. Loan losses absorbed more than half of this aggregate. In this newly delicate phase on the markets Italian banks’ ability to raise funds has not diminished. Their one-month liquidity position continues to be more than satisfactory, thanks among other things to their ample endowment of assets eligible for refinancing operations with the ECB. Bank credit is showing signs of recovery. In the three months ending in May, lending to firms grew by an annualized 2.1 per cent on the three preceding months and that to households by 5.0 per cent. Firms’ demand for credit is on the rise. Customer protection To protect retail customers, who represent the strength of the Italian banking system, is an objective the Bank of Italy is pursuing with great determination. In the last few years we have issued radically new rules in this field, laid the foundations for banks to supply simpler and cheaper products that make it easier for weaker consumer to access financial services, and prepared guidance that helps even the least expert customers to make choices consistent with their needs. Where – as in loans and overdrafts – the risk of opacity is greatest, we have introduced additional defences, carried out investigations and put forward proposals to improve the law. The Banking and Financial Arbiter (ABF), for which the Bank of Italy provides the resources for its operation, has ruled in favour of the customer in 60 per cent of the cases it has examined. The customers who incurred losses have been indemnified. The ABF’s rulings strengthen the protection of customers not only in individual cases but also more generally because they guide banks towards correct behaviour. The checks made at banks’ branches, head offices and websites assess not only formal compliance with the new provisions on transparency but above all the degree to which customer relations are correct in substance. The checks on non-bank intermediaries and their distribution channels are more severe today, and the requirements for entry in the register referred to in the Consolidated Law on Banking are stricter. We have intervened in the situations where the anomalies were most notable: loans secured by pledge of salary, revolving credit cards, the issue of guarantees, foreign exchange dealing and money transfers abroad. We have stepped up cooperation with the Finance Police, especially in the sectors most involved in criminal investigations. Additional safeguards for consumer protection are now being discussed. We have worked with the Government on the transposition of the European directive on consumer credit. The intention, properly, was to take this opportunity to carry out a broader reform, one that would also tackle the regulation of non-bank intermediaries and their channels of distribution. The reform bill is now before Parliament: it is essential that the proposed self-regulatory bodies have the tools and the means to work to good effect; that only reliable intermediaries inhabit the market; and that the granting of credit be restricted to institutions subject to supervision, with extremely limited exceptions. The crisis has shown the importance of promoting the acquisition of adequate financial knowledge. In this area, too, the Bank of Italy has stepped up its activity. The experimental financial education programme for schools developed together with the Ministry of Education, Universities and Research has continued during the past academic year; the considerable improvement in knowledge that has been observed encourages us to pursue and expand the programme. Measures to combat money laundering The infiltration of criminal elements into economic activities has become diffuse, partly as a result of the crisis. The banks are the cornerstone of the battle against this degeneration. They must have a thorough knowledge of each customer and assess the risk of their involvement in illicit dealings. The Bank of Italy has tightened the application of rules and controls further. The inspections performed at numerous bank branches – 120 in late 2009 and early 2010 – have brought to light widespread shortcomings in the scrutiny of clients, the training of personnel, and the procedure for reporting suspicious transactions. The role of the senior management of banks is crucial: combating money laundering must be made part of corporate culture, including suitable systems of incentives and compensation. *** The path for economic policy today is narrow and arduous. There is no alternative but to consolidate the public finances, unwind the monetary expansion, recapitalize the banking system, and return to a culture of stability, which is the founding characteristic of the euro area. But there is also no alternative to a resumption of economic growth, without which these very objectives become unattainable. Growth that is not driven either by debt or by monetary policy but whose engine, especially in Italy, is reform and corporate technological innovation. The banks have a special role to play in sustaining growth. If they are strong they will be – they are – a pillar of growth. But we also want banks that are once again close to the productive economy, as they were before the crisis. There is only one way to do this: “know how to discern a creditworthy firm even when the numbers are against it”. The whole agenda is ambitious. It demands an extraordinary capacity for analysis, exceptional know-how, great willingness to innovate and change. If undertaken resolutely and equitably, this programme will have the wholehearted support of markets and the entire population. | bank of italy | 2,010 | 7 |
Speech by Ms Anna Maria Tarantola, Deputy Director General of the Bank of Italy, at the conference on financial stability and the contribution of deposit insurance, Rome, 30 September 2010. | Anna Maria Tarantola: Strengthening financial stability – the contribution of deposit insurance Speech by Ms Anna Maria Tarantola, Deputy Director General of the Bank of Italy, at the conference on financial stability and the contribution of deposit insurance, Rome, 30 September 2010. * * * Good morning. I would like to welcome all of you to the Bank of Italy. We are very pleased to be able to host this year’s conference on financial stability and the contribution of deposit insurance. 1. The EU banking sector after the crisis Three years after the onset of the financial crisis, the EU banking system has made important strides. These have been a long and difficult three years, but positive signs are evident. In the first half of 2010, profits rose at the major EU banks. In some cases income was significantly higher than in 2009; other banks reporting negative results last year have now returned to profitability. Loan impairment and bank provisions were reduced, as the recovery in the real economy gained momentum. The EU-coordinated stress tests published in July showed that banks have strengthened their capital base and are in a position to bear additional losses should the macroeconomic outlook deteriorate. However, despite these positive trends, considerable uncertainty still surrounds the banking sector. Credit risk remains high and if, as recent signs indicate, the international recovery decelerates, credit risk could increase further. While moderate economic growth remains the most likely scenario for Europe, it remains vulnerable to a moderation in international trade. It is also not ensured that bank earnings will continue to be as sustained as in past months when they were supported by factors that may prove to be temporary: trading profits have been falling; and net interest income, though still strong, could be negatively impacted by a sudden flattening of the yield curve. Especially worrisome are risks stemming from the interplay between sovereign debt problems and fragility in the banking sector; these are particularly acute in EU countries with large fiscal imbalances. In past months, we saw budgetary pressures having dramatic spillover effects on bank funding in some countries; at the same time, signs of instability in the banking sector had negative repercussions on sovereign issuers. Bank refinancing is another major concern. EU banks will soon need to begin rollingover very large amounts of debt. Given that public-sector requirements will also be rising, access to market funding could become even more difficult. In fact, we are observing greater polarisation among banks. Stronger institutions can access the markets. Others are experiencing difficulty and remain dependent on government support and central bank financing. Today policy makers face a very demanding task. Dispelling market concerns over sovereign debt risk is imperative: progress in fiscal consolidation must remain a priority for EU member states. Yet equal attention must be devoted to supporting growth in the medium term. In evaluating longer-term sustainability, markets are paying increasing attention to a country’s ability to generate economic growth. Therefore, to the greatest degree possible, consolidation measures should be growthfriendly and accompanied by structural reforms in the EU. The goals for regulators and supervisors are no less challenging. We must safeguard the stability of the financial sector, and rebuild its solidity, while ensuring that the provision of credit and financial services to the economy is not impaired. Weaknesses and distortions revealed in the crisis must be corrected, so that credit institutions can fully support economic growth in the future. It is essential that in coming years we have fully restored the banking sector’s ability to perform activities essential to our economies. This is possible when there is a solid and stable system. 2. The regulatory reform: priorities ahead A fundamental step towards achieving these objectives has been made by the Basel Committee on Banking Supervision (BCBS) with the agreement on the new bank capital and liquidity standards. The standards will markedly increase the resilience of the banking system, by constraining the build-up of excessive leverage and maturity mismatches that provided the fuel to this crisis. It is clear that the new rules will impose some costs – in terms of profitability – for the banking industry. However, these costs will be compensated by the fact that we will all (including bankers) live in a safer financial environment. Moreover, the transition phase to the new rules has been designed so that costs can be absorbed in a gradual manner and the recovery is not jeopardized. The Basel agreement, for all its importance, does not however exhaust the need of reform in the financial system. An urgent step is to solve the moral hazard problems associated with systemically important financial institutions (SIFIs), also known as the “too-big-to-fail” (TBTF) problem. These problems have increased as a consequence of the extraordinary public interventions during the crisis and probably represent the most daunting legacy that regulators must now confront. If we do not address this issue with determination, SIFIs will continue to have incentives to engage in excessively risky activities; accurate monitoring by investors will be much weaker than desirable, with the result that future crises may be more likely. Finally, we must be aware that the public will not accept a repetition of the widespread bailing-out of SIFIs that was necessary during this crisis. A clear political message has emerged at international level (Pittsburgh G-20 meeting Sept.2009), strongly backed by the EU, that taxpayer money should not be used again to cover bank losses. Elaborating measures to effectively tackle “too big to fail” is now the priority of the Financial Stability Board (FSB), which will present its recommendations to the G20 in November. The FSB is assessing a broad range of policy options to reduce the probability and the impact of a crisis involving SIFIs. They include inter alia the introduction of prudential instruments, such as capital and liquidity surcharges above those agreed in Basel, the use of contingent capital (i.e. the possibility to convert debt into equity either by statutory resolution mechanisms or by private contractual arrangements) and the standardization and trading of OTC derivatives on electronic platforms with clearance by central counterparties to reduce the interconnectedness of financial institutions. But particularly important, especially to establish the right set of incentives for SIFIs, is the FSB’s program to set up effective resolution regimes, both at the domestic and cross-border level, to be able to manage in an orderly way the eventual failure of SIFIs. Only if we succeed to organise a mechanism through which SIFIs are allowed to fail, while limiting to the maximum extent the systemic risk involved, can we ensure that SIFIs behave in a correct manner and thus reduce the probability of future crises. The issue therefore merges into the broader question of establishing principles and tools for an effective crisis management system, a theme that involves many aspects that will be addressed in the rest of this conference. Let me briefly touch upon some of them. 3. Strengthening the toolbox Role of authorities, preventive action and resolution regimes A first crucial issue involves the role and powers of authorities. The crisis has highlighted that the intensity and effectiveness of the supervision of SIFIs must be stepped up, particularly with regard to both preventive action and resolution powers. This will be possible, in some cases, only by reinforcing the mandates, independence and resources of national supervisors. With regard to preventive action, supervisory powers and resources must be reinforced so that Authorities can quickly detect early signs of deterioration and intervene as soon as possible to reduce the probability and impact of a SIFI failure. National supervisors should have the powers to apply differentiated supervisory requirements for institutions based on the risk they pose to the financial system. They should have the power to intervene effectively at an early stage, to mandate changes within an institution, to prevent unsound practices and ensure appropriate countermeasures including capital and liability restructuring. With regard to resolution powers, an effective resolution regime must provide Authorities with the powers and tools to wind-down a firm quickly and safely, while ensuring the continued performance of essential financial functions and uninterrupted access of insured depositors to their funds in order to contain systemic risk. Authorities must possess all the tools that facilitate “gone concern” restructuring and winddown measures, including the establishment of a temporary bridge bank to take over and continue operating critical functions. Cross border perspective A second crucial aspect for an effective resolution mechanism regards cross-border multinationals. In the past three years, cross border issues have added a layer of complexity in dealing with bank crises. The international dimension of financial institutions increases the scope for cross-border contagion and thus the likelihood of a systemic crisis across countries. Moreover, reaching rapid and clear agreements at cross border level proved to be, in some circumstances, a very complicated exercise. Perhaps this should come as no surprise. To some extent, it is a direct consequence of the inconsistency between, on one hand, the size, complexity and interconnectedness of large banking groups – operating far beyond national boundaries – and, on the other hand, the enduring fragmentation of the national legal and regulatory frameworks. The Basel Committee recently published a report on Cross Border Resolution, which contains a set of recommendations intended to strengthen national resolution powers and cross-border implementation. The report underlines, inter alia, the need to further converge on a common set of effective tools and improve information sharing in crisis management. The report addresses the issue of complex banking group structures and recommends using regulatory incentives when complexity could create an obstacle to an orderly and costeffective resolution; capital or other prudential requirements should be designed to encourage organizational structures that facilitate effective resolution. The Financial Stability Board is also working to remove obstacles that can obstruct the effective implementation of recovery and resolution measures in complex cross-border institutions. It has identified four technical areas that need to be addressed: i) complexities arising when trades are marketed, booked, funded and risk-managed in different legal entities and jurisdictions; ii) difficulties in disentangling group structures when the parent or lead bank has issued guarantees to support particular transactions by affiliate entities in foreign jurisdictions; iii) the preservation of global payment operations; and iv) the adequacy of a firm’s ITC systems to provide firmwide and single legal entity information, especially to support recovery and resolution actions. Moreover, on the prompting of the FSB, Cross-Border Crisis Management groups have been established worldwide for most of the largest global financial institutions. The focus of these groups is to establish firm-specific Recovery and Resolution Plans that will help authorities and firms handle emergency situations and enhance mutual trust among key home and host authorities. Further progress on the recovery and resolution plans could be achieved by reforming resolution regimes in different countries. At EU level, it appears necessary to work in two directions. First, cooperation among authorities must be improved in dealing with emergency situations involving cross border groups. The June 2008 Memorandum of Understanding on cooperation between the financial supervisory authorities, central banks and finance ministries of the European Union on crossborder financial stability needs to be fully applied and strengthened. Second, we must proceed quickly to better harmonize insolvency laws across the Union, starting with those principles and procedures most directly connected with crisis management. A building block of any crisis management system is the effective and efficient work of colleges of supervisors. They are the natural body where possible and viable ways forward on a co-ordinated approach to crisis resolution can be discussed and organised (contact lists, stock-taking on legal and regulatory frameworks, data collection, procedural and organisational aspects of crisis management including possible scenarios of burden sharing). As a home supervisor, the Bank of Italy has put much effort in setting up these colleges and making them work, coordinating the process for all cross-border groups it supervises, and convening meetings of the Cross-Border Stability Groups and Crisis Management Teams for Italian banking groups. The new European Banking Authority will certainly play a crucial role in developing an effective system to deal with crisis situations in Europe. 4. Funding the recovery or the orderly resolution. Who bears the cost? A harmonised approach for dealing with weak or ailing institutions necessarily raises the question, “Who shall bear the costs?”. Based on the principle that taxpayers should never again bear the burden of future financial crises, priority clearly must always be given to private-sector solutions (including recapitalizations, ownership transfers, purchases & assumptions), ahead of any other source of support and certainly before taxpayer money is tapped. However, as these options may prove insufficient or unviable in particularly serious cases, we must also prepare valid alternatives. Various mechanisms are being discussed, including: Haircuts Haircuts on creditors or “bail in” instruments have been recently proposed as one of the most promising tools for increasing the loss absorbing capacity of financial firms, beyond the capital base. Statutory bail-in would allow authorities in a going concern situation to wipe-out creditors, before the collapse of the firm. However, it would entail harmonizing global rules on creditor preferences and imposing bail-in conditions on pre-existing contracts. Contractual bail-in, on the other hand, would force institutions to issue a portion of senior debt, to be determined by regulation, that could be either written down or converted into equity in a public intervention procedure. There are also potential drawbacks in this option as it would introduce a distinction between “investors” and “customers”, with the latter being less concerned about a careful monitoring of the bank. Nevertheless, it is clear that this is a route to be further explored. Private resolution funds A privately-financed European Recovery Fund has also been proposed. This would be designed to facilitate emergency medium-term funding when liquidity shocks, in distressed capital markets, threaten banks that are otherwise solvent and profitable. It would be financed by voluntary contribution of the top twenty European banks. Although private, the fund would only intervene when European authorities determine that a bank needs support, providing guarantees at market conditions. This could be an important resource for overcoming difficulties in certain situations, but it is essential for authorities to consider the capacity of the banking system to finance both a resolution fund and an insurance scheme; an additional question is whether a private resolution fund would duplicate DGS that act as “beyond pay box” instruments. Ex-ante resolution funds In addition, the EU Commission has recently proposed establishing a system of EUharmonized resolution funds (COM 2010/254), aimed to facilitate the resolution of failing institutions. The funds would be financed by imposing levies on banks. To avoid moral hazard, these funds should be activated only as instruments of last resource, after exhausting all private sources of financing. Within a clear resolution framework, it could provide a useful instrument to help authorities liquidate banks in an orderly manner, by covering administrative costs, financing the total or partial transfer of assets and/or liabilities, or financing bridge banks. A number of countries have recently introduced (Sweden and Hungary) or announced plans to introduce (Germany, France and the UK) bank levies, though the objectives and implementation schemes differ significantly. Considering the current conditions of the financial sector and the costs that banks will incur to conform with the new capital standards, in my opinion the timing of additional expense should be assessed carefully. However, if such initiatives are pursued, it is important that they proceed in a coordinated manner and, in this sense, the Commission’s proposal appears to be a sensible way forward; a number of issues, related for example to the precise scope, financing and governance of resolution funds still need to be addressed. The role of DGS Deposit Guarantee Schemes should be able to absorb the impact of medium magnitude crises or, where possible, to promptly intervene to avoid bank failures in the interest of depositors. The more effective a DGS, the greater will be depositor confidence, reducing the risk of bank runs and limiting contagion from banks in distress. Much work is underway at international fora to strengthen the role of DGS. The effort to harmonise and enhance their risk minimiser role is particularly welcomed. The contribution that DGS can bring to open market solutions, helping to preserve the continuity of important business activities and avoid the disruption of customer relationships, mainly in the interest of depositors, will be increasingly important. The important collaboration between the Basel Committee and the International Association of Deposit Insurers (IADI), who joined forces to address a range of issues including coverage, funding and reimbursement, resulted in the “Core Principles” focusing on, among others, public awareness and cooperation with other safety-net participants, including central banks and supervisors. The principles are designed to be adaptable to a broad range of country circumstances, settings and structures. The “Core Principles” form a non-compulsory framework for deposit insurance. However, they are testimony of the will to establish best practices for national authorities committed to enhance or put in place effective deposit insurance schemes. The EU Directive on DGS Steps taken in the EU to strengthen the regulation on DGS move in the right direction. The Commission proposal of July 2010 aims to enhance depositor protection and convergence of EU DGS by harmonizing scope, coverage and funding mechanisms. It raises fixed coverage to €100,000 per depositor, significantly reduces the payout delay, and institutes a funding mechanism based mainly on ex-ante contributions. The proposal also explicitly provides for the preventive intervention of DGS to avoid bank failure. There are still technical issues to be addressed, since the current proposal lacks reference to the least cost criteria and authorisation processes. Nevertheless, the recognition of DGS as preventive actors in helping to avert worst crisis scenarios is welcomed. It could provide the necessary impulse for implementing this feature in EU countries where DGS currently lack such role. Pan-European Deposit Guarantee Scheme In the course of recent work to strengthen the European financial system, the question has been raised repeatedly as to whether a single pan-European deposit guarantee scheme could be a feasible option. It would certainly allow for significant savings in administrative costs (estimated at about € 40 million per year). Moreover, a pan-European scheme could ensure better management of bank failures because the impact of a bank failure on a large scheme would be smaller than on an individual Member State DGS. Furthermore, in a crossborder banking crisis, a pan-European scheme could provide incentives for a pooled solution in the interest of all depositors, regardless of nationality. However, owing to the complex legal issues arising from differences in national legal frameworks and the absence, at the moment, of an integrated European supervisory and crisis management framework, this idea is still a longer-term project. 5. Conclusions Let me conclude my remarks by stressing two aspects that, in my opinion, are at the core of the issues addressed at this conference. First, international cooperation and rule harmonization must be significantly stepped up. Establishing an effective crisis management system, including a clear resolution framework, is the road we must undertake to reduce the likelihood of future crises and contain their damage should they nevertheless occur. In a context where financial institutions operate globally, we can succeed only by increasing cooperation, coordinating action and reaching a much higher degree of harmonization of our domestic systems. In Europe, this is of utmost importance if we wish to strengthen the single market and ensure a level playing field for all financial actors. Second, in the field of supervision, the harmonization of practices is at least as important as the harmonization of rules. The introduction of a common set of rules, powers and tools should be complemented by the development of common methodologies, among supervisors, to assess the ongoing risks faced by cross-border banking groups and to develop common assessment. This is essential to achieve shared decisions and would greatly facilitate coordinated solutions in an emergency situation. Progress must be made rapidly, now, taking advantage of the momentum in international cooperation that has gained ground with the crisis. It would be unforgivable to remain unprepared. It would mean confronting future emergencies from a much weaker position than we had when this crisis first emerged. At the European level, there are encouraging signs that we are moving in the right direction. There is increasingly greater awareness of our interconnectedness and the response, though hesitant at first, has been more Europe, not less. I have no doubts that the new financial supervisory architecture and the authorities that will come into force next year will make great strides to provide the impulse and vigour to move forward and achieve the necessary goals of this process. | bank of italy | 2,010 | 10 |
Remarks by Mr Ignazio Visco, Deputy Director General of the Bank of Italy, at the Global Economic Symposium 2010, Istanbul, 29 September 2010. | Ignazio Visco: Rebalancing trade and capital flows Remarks by Mr Ignazio Visco, Deputy Director General of the Bank of Italy, at the Global Economic Symposium 2010, Istanbul, 29 September 2010. * 1. * * The role of macroeconomic policies in the global crisis Policy responses to the global crisis have helped stabilize confidence and limit the threats of financial instability, but at the cost of a huge accumulation of public debt. This could potentially lead to a higher cost of borrowing if markets were to become concerned about its sustainability, and of a protracted period of very low policy interest rates and abundant liquidity, which may end up fuelling new asset price bubbles, thus building up the conditions for the next crisis. In order to reduce the risk that again in the future a combination of distortions may lead to large and destructive financial crises, it is essential to address both macroeconomic and financial policy failures. Important changes in financial market regulation and banking supervision are already being introduced. In the macroeconomic area, an effort is being conducted to strengthen the coordination of economic policies in the context of the G-20. Beyond exiting from exceptional expansionary policies, the global economy will face the challenge of adapting to an extended period of higher private saving in the advanced economies, where the process of deleveraging is still at its early stages. A shift to a more sustainable global pattern of demand is needed, with important policy implications to facilitate this adjustment over the medium term. Policy frameworks should adjust to allow for stronger growth in private demand in economies with substantial external surpluses that have accumulated large reserve positions over the past several years. In other words, the composition of global demand will need to shift in order to deliver strong, sustained and balanced global growth, as in the G-20 intendments. Supply-side policies and structural reforms will be important to support potential growth – which may have been damaged by the crisis. One may wonder what would have happened to the global economy had this policy framework been implemented in due time. Such a counterfactual scenario has been studied by Catte et al. (2010) who show that, if a substantial and globally coordinated demand rebalancing had been undertaken in the early 2000s, internal and external imbalances would not have accumulated to the extent that they did (Catte, P., P. Cova, P. Pagano, and I. Visco (2010), “The role of macroeconomic policies in the global crisis”, Banca d’Italia Occasional papers, No. 69, July). In particular, the scenario considered contemplates tighter monetary and supervision policies in the United States and an increase in domestic demand in major surplus economies. The latter would have been the result of wealth effects obtained through productivity enhancements in the nontradable sector in advanced surplus economies and of policies aimed at directly rebalancing growth towards domestic demand – such as measures that reduce households’ precautionary savings and reforms of corporate governance which decrease retained earnings, coupled with exchange rate appreciation – in emerging economies. Even though it is difficult to say whether in that scenario the financial crisis might have been avoided, its propagation would likely have been less destructive, as both the US financial system and the global economy would have been less vulnerable to it. Specifically, US housing prices would not have expanded at the same pace as they did and the pattern of current accounts would have been better balanced. Overall, the results of such a counterfactual scenario highlight the complementarity of policy actions in deficit and in surplus countries with respect to the correction of both internal and global imbalances. Notwithstanding announcements about the importance of coordination and cooperation in the design and development of crisis strategies, in practice, countries have proceeded to adopt policies that appear to be national in character. Strengthening multilateral coordination to mitigate global distortions remains a priority. The issue of cooperation extends beyond the design and implementation of stabilization policies and appears particularly relevant in managing exchange rate flexibility. 2. Exchange rate flexibility and financial flows For countries in surplus, the rebalancing toward domestic demand should normally be accompanied by an exchange rate appreciation to help re-direct production toward nontradables and part of the additional absorption toward imports. The consequent terms-oftrade gains would help stimulate domestic consumption. In principle, an effective exchange rate appreciation can be achieved in different ways depending on the exchange rate regime. Greater exchange rate flexibility could, for example, take the form of exchange rate fluctuation within a moving (e.g. gradually appreciating) target band, defined with reference to either the dollar or a currency basket. It is possible to imagine a wide range of variants of this regime depending on the width of the band, the speed of appreciation, the composition of the basket and whether the margins of the band are “hard” or “soft”, as well as depending on the degree of pre-commitment to each of these parameters. In the case of China, for example, while the appropriate size of the renmimbi’s appreciation will depend on considerations of macroeconomic balance in the context of the ongoing demand rebalancing, the degree of exchange rate flexibility could be used as part of the authorities’ strategy for addressing the need to manage the effects of capital inflows while preserving domestic macroeconomic and financial stability. For countries facing large capital inflows, greater exchange rate flexibility may represent the most effective line of defence, reducing the need to accumulate official reserves. The main challenge posed by capital inflows for fixed-exchange-rate countries is to prevent them from feeding excessive growth in domestic credit, asset market booms and inflationary pressures, given the difficulty of fully sterilizing the domestic effects of reserve accumulation in a context of limited development of the internal financial market. While a crawling peg does not provide greater monetary autonomy than a fixed exchange rate (it may even require maintaining lower interest rates than those in the anchor currency), exchange rate flexibility – even within the limits of a fluctuation band – introduces a perception of two-way exchange risk, which should help discourage one-sided speculative bets on a renminbi appreciation. This buffering effect will be greater if the fluctuation band is sufficiently wide. Such a regime would allow greater leeway for an autonomous monetary policy: a rise in domestic interest rates would normally be associated with a more appreciated exchange rate within the fluctuation band, and thus with greater scope for future depreciation; it would not, therefore, trigger capital inflows if the band is credible. A possible second line of defence in the face of excessive capital inflows, particularly when these are a structural phenomenon, could be greater liberalization of capital outflows. This should be part of a broader process of fostering domestic financial development, both in order to ensure an efficient allocation of the country’s huge pool of savings and to support China’s increasingly globalized and sophisticated companies. Related to this broad project is also the objective of enhancing the role of the renminbi as an international currency. In this context, the introduction of some degree of exchange rate flexibility (possibly increasing over time) can be seen also as a way of gradually allowing domestic investors and firms to familiarize with the management of exchange risk. Here the interaction with financial market development is important: as domestic firms and banks become exposed to currency risk, they need to be given access to markets where they can hedge against it. On the other hand, liquid derivative markets are unlikely to develop unless a demand for hedging exists. At the same time, the development of deep and open markets in a broad range of renminbi financial instruments – an essential condition for China’s currency to take on a major international role – requires a switch of the monetary policy strategy from quantitative targets to the use of the interest rate and open market operations. This requires financial deregulation and the development of a liquid secondary market for government bills and bonds, so that the latter may act as a reference to price riskier private assets. 3. Reserves and the international monetary system Over the past decade international reserve holdings have become increasingly concentrated in the hands of emerging market countries, and have grown well above traditional “precautionary” norms (e.g., in terms of months of imports or as a ratio to short-term external debt). As well, global reserves have remained concentrated in a few currencies, particularly the US dollar, whose share in global reserve assets far exceeds the share of the US in the global economy. These developments are a symptom of unsolved problems in the underlying international monetary system (IMS). Large-scale reserve accumulation has significant costs at both the national level (in terms of foregone consumption and investment, or quasi-fiscal deficits incurred when reserve accumulation is financed or sterilized with debt offering higher yields) and the global level. Beyond the traditional motives for holding reserves (such as smoothing out the impact on consumption of shocks or ensuring inter-generational equity for oil producers), recent largescale reserve accumulation has been driven by two main factors: (a) growing and volatile capital flows – and the related need to insure against international liquidity shocks for countries with an only limited financial intermediation capacity; and (b) the absence of automatic adjustment mechanisms in global imbalances – policies aimed at maintaining an undervalued exchange rate can persistently put off adjustment for surplus countries. As long as reserve issuing countries are willing to incur debt to purchase their imports, an export-led strategy leading to persistent current account surpluses and reserve accumulation remains a feasible policy option. However, as economies relying on undervalued exchange rates and demand from reserve issuers grow larger, a purely domestic adjustment for the reserve issuers becomes increasingly difficult. Both “precautionary” and “non-precautionary” reserves have a bearing with IMS stability, but require a different treatment. To reduce the world demand for precautionary reserves, the definition of benchmarks to gauge the adequacy of precautionary reserves, such as IMF guidance on “desirable” ranges of precautionary reserve levels based on country circumstances, could be helpful. To address the other underlying driver of reserve accumulation (capital flow volatility), countries could agree, also with the help of the IMF, on a new multilateral framework for managing capital flows. This framework should (i) cover all types of capital flows; (ii) specify the benefits of capital account liberalization under specific circumstances, as well as the need of appropriate measures to contain excessive movements if and when necessary; (iii) discourage systemic countries from adopting comprehensive capital controls that may generate greater capital flow volatility elsewhere, or are used in place of policy measures aimed at decreasing global current account imbalances; and (iv) encourage countries to take concerted actions to limit volatility of capital flows. This would require substantial enhancement of financial data gathering at the national level, as well as more timely monitoring of capital flows at a supra-national level. Countries’ perceived need of precautionary reserves is not entirely independent of the amount of IMF resources they can count on in case of trouble. Substantial progress has been made in recent times, with the creation of a new precautionary facility for countries with sound fundamentals and policy frameworks and the tripling of Fund resources. Further improvements are being debated to encourage the use of IMF precautionary tools and broaden the perimeter of their potential beneficiaries. Yet, as IMF lending remains attached to some form of “conditionality”, countries may still prefer accumulating reserves, which are available immediately and unconditionally. A more ambitious option would be to do without IMF conditionality, and allow the Fund to lend to solvent countries against collateral (in the form of high-quality assets possessed by the borrower), on a temporary basis and at penalty rates. This would require an amendment to the Fund’s Statutes, since lending against collateral is not currently allowed by the Articles of Agreement. The search for incentives to reduce “non-precautionary” reserves explained by one-sided foreign exchange intervention remains problematic, as IMS stability is likely to be of second order importance to countries’ own near-term interests. At a bare minimum, a “shared understanding” would be required among surplus and reserve issuing countries on the stability requirements of the system and on how their behaviour can undermine its stability. This understanding could be achieved either informally – at the G-20 level, through the “framework for strong, sustained and balanced growth” – or in a more institutionalized context for international cooperation such as the IMF. A concerted, non-coercive approach would be surely preferable to one based on “penalties” (including a threshold on “excess” reserves or automatic taxes on persistent current account imbalances for reserve issuers). This approach should contemplate: (i) for reserve accumulating countries, a move towards flexible exchange rates and a significant reduction of foreign exchange intervention, or the abandonment of their pegs to national currencies; (ii) for reserve issuers, the adoption of a macroeconomic (fiscal) policy framework to sustain credibility of their currencies and the IMS as a whole. More ambitiously, steps could be taken to strengthen the global reserve system by (iii) enhancing the role of the SDR. This said, both in the G-20 and IMF settings the question remains as to how to make countries accountable ex post for the implementation of these understandings. A more diversified allocation of reserves among existing (or newly created) assets could, in principle, reduce global and individual exposure to risks stemming from economic shocks and policies of a single country, and provide more stable stores of value by increasing reserve issuers’ incentives to pursue sound policies. Reserve diversification is a marketdriven process that is unlikely to evolve rapidly without active promotion of the official sector. In addition, in the absence of greater policy coordination between reserve issuers to manage their exchange rates within acceptable ranges, a multi-polar system (with several reserve currencies operating as broad substitutes) may entail greater exchange rate volatility, especially in the transition phase. Thus, the diversification process should be managed in a smooth and transparent way, to avoid large swings unwarranted by economic conditions. The Fund could (i) promote greater transparency and an only gradual adjustment in the currency composition of reserves, (ii) engage with potential major reserve issuers to help remove the obstacles to a broader use of their currencies, and (iii) assist emerging market countries to pool and securitize part of their sovereign debt into a new composite asset, to be held as reserve asset by the members of the pooling arrangement. Finally, and certainly more open to discussion, the SDR may offer a number of potential advantages as a new element (if not a currency) of a multi-polar system. Being a basket of major currencies, it diversifies the currency and interest rate risks of its constituent currencies, and this would be especially important to cope with greater exchange rate volatility in a system with no dominant currency. Another advantage would be to align global “monetary conditions” (i.e., the reference rates off of which risky assets are priced) more with global conditions than with conditions in any single economy – all the more so if the basket were broadened. Finally, if countries with a current account surplus pegged to the SDR basket rather than to a national currency, the currencies of deficit countries could depreciate vis-à-vis others in the basket. However, for the SDR to become a viable reserve currency, its supply should be increased significantly, and deeper and more liquid markets for this asset would be needed (currently there only exists an “official” market for SDRs). Over the years, SDR allocations have been regularly resisted by major IMF members. The development of a private SDR market would facilitate the process of diversifying reserve composition. Moreover, if the private SDR market were sufficiently liquid, it would become possible to carry out foreign exchange intervention directly in SDR. This might encourage countries to set their exchange rate vis-à-vis the SDR rather than the dollar. It would take time to ensure that a liquid, broad and diversified private market for the SDR develops, although the Ecu experience suggests that it could also prove highly successful. An important limitation that needs to be taken into account, however, is the absence of a lender of last resort in SDR. Market agents would always need to ultimately rely on the central banks issuing the four constituent currencies of the SDR basket. | bank of italy | 2,010 | 10 |
Keynote speech by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the Peterson Institute for International Economics - Bruegel Conference, Washington DC, 8 October 2010. | Mario Draghi: The transatlantic relationship in an era of growing economic multipolarity Keynote speech by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the Peterson Institute for International Economics – Bruegel Conference, Washington DC, 8 October 2010. * * * Let me start by thanking [Fred, the IIE, Bruegel] for inviting me to this policy debate on regulatory reform and transatlantic relations. The issues on the conference agenda are highly topical and present challenges for international policy makers. Just as is the case for tackling the problem of global climate change – another important topic on your agenda – achieving a more stable and resilient global financial system requires coordinated action at the global level. The US and Europe have strong joint interests in this and are critical to progress. But so are the growing weight of countries beyond these continents, and they have come to play an increasingly important role in shaping global outcomes. In my remarks I will first review what we have achieved so far in terms of financial reforms. I will then turn to important challenges still ahead of us. And I will conclude with thoughts on international policy coordination and the role of the FSB. Achievements so far We have come a long way towards strengthening the financial system since this crisis began, reflecting an unprecedented amount of international co-ordination in achieving consistent reforms. While issues remain to be resolved, in Europe, in the US and elsewhere, we are, collectively, fundamentally reshaping the framework for systemic financial oversight. Let me note some examples: – First, top-down, system-wide oversight arrangements are being put in place at national, regional and international levels. These arrangements are designed to deliver more encompassing surveillance, with broadened macro-prudential perspectives, and better mechanisms for triggering action on identified risks. Examples are the European Systemic Risk Board and related arrangements, the US Financial Services Oversight Council, the IMF-FSB Early Warning Exercise, and the establishment of the FSB itself. – Second, major jurisdictions have overhaulied their regulatory and supervisory structures to strengthen responsiveness to risks, improve coordination and close gaps. The FSB is in many ways the international manifestation of these efforts; – Third, the regulatory perimeter is being expanded. Major jurisdictions have finalized or will shortly finalize legislation that establish regulation and oversight over the OTC derivatives markets, hedge funds and credit rating agencies. In each of these areas, principles for what regulation should achieve have been internationally agreed and implementing regulation is being closely coordinated; – Fourth, we have put in place cross-border oversight and contingency planning for the largest and most complex global financial institutions, each of which now have functioning core supervisory colleges and crisis management groups. At the level of the essential regulatory policies to buttress financial stability, let me recall: – that with Basel III, we have a fundamentally revised global bank capital framework which will establish stronger protection through improved risk coverage, more and higher quality capital, a counter-cyclical buffer and a constraint on the build-up of banking sector leverage; – Second, as part of Basel III, we will for the first time have a global liquidity standard for banks that will promote higher liquidity buffers and constrain the maturity mismatching that created the condition for this crisis; – Third, as I will describe later, we are making progress in developing a policy framework and tools to roll back the moral hazard risks posed by institutions that are TBTF; – Fourth, we have eliminated the perverse incentives that pervaded securitization, including the scope for leverage to develop in opaque off-balance sheet vehicles through changes to accounting standards and regulatory and prudential rules; – Fifth, we are establishing central clearing of standardised contracts in the OTC derivatives markets and a OTC global trade repository is now in operation; – Fifth, we have developed a series of supervisory tools to raise standards of governance, risk management and capital conservation at financial institutions. In this context, let me note that: we are making good progress with accounting standard setters towards expected loss provisioning regime for credit losses, which will dampen procyclicality and align accounting and prudential objectives in this key area; and principles and standards have been issued to better align compensation systems with prudent risk-taking. The standards give supervisors powers to restrain compensation structures and the level of pay-out to conserve capital in the firm. As we move to raise capital levels, we will encourage supervisors to use these powers. I have been selective in my enumeration. But the point I want to leave with you is that we should not underestimate what has been accomplished. Each of the above areas are difficult in their own right. That we have been able to progress global policy development and implementation on such a broad front, while fighting a very serious financial crisis, is something that has never happened before. So, the direction in which we are moving internationally is encouraging. But important issues remain. And it is political resolve that will determine whether we accomplish the credible and robust reforms that our citizens rightly demand, yet preserve the enormous advantages of an internationally integrated financial system. Addressing TBTF Addressing the “too-big-to-fail” (TBTF) problem is perhaps the most challenging remaining legacy of the crisis. Basel III will greatly strengthen banking system resilience, but it does not address this problem. The FSB has assessed a broad range of policy options in this area and will present its recommendations to the G20 in November. It is important to recognise that SIFIs vary widely in structures and activities and that the nature and degree of the risks they pose also differ. Some are large, complex highly integrated global financial institutions with activities spanning a range of sectors. Others may have a global customer base but are simpler commercial banking operations. Yet a third category is entities that are large at a domestic or regional level but nonetheless globally interconnected through wholesale funding markets. Whatever their nature, SIFIs have two things in common: that their uncontrolled failure would cause significant systemic disruption and that we, as authorities, cannot at present resolve them in an orderly fashion without use of public funds. The framework we have agreed to address SIFIs is therefore based on four necessary pillars. First, we must radically improve our capacity to resolve SIFIs without disruptions to the financial system and without taxpayers’ support. Effective resolution regimes must advance the goals of both financial stability and market discipline. This means they need to be able to impose losses on shareholders as well as creditors while ensuring continuity of essential financial functions. All countries should have a Dodd Frank style regime in place. In addition, we need to acquire additional resolution tools. The bail-in of debt holders holds significant attractions both from the perspective of correcting creditor incentives and protecting tax payers. But the legal issues associated with the bail-in in group structures and in a crossborder context are non-trivial. Moreover, to be effective backstops in dealing with global firms, national resolution regimes need to converge towards common standards. And these need to be supplemented by cross-border cooperation arrangements underpinned by national law that provides both mandate and capacity for resolution authorities to cooperate. Legislative changes will be needed in many countries to enable this. Lastly, “living wills” will be mandatory for major firms. These will include assessments of firm resolvability. Supervisors will have the power to require changes to a firm’s structure to improve its resolvability. Second, the loss absorption capacity of systemic firms should reflect their role in the global financial system and their potential contribution to systemic risk. Even with the best possible resolution tools, the failure of a major global firm would cause significant damage. This reinforces the importance of strengthening the resilience of major global firms. Higher loss absorption capacity for SIFIs than the minimum agreed Basel III standards, especially for the largest globally operating SIFIs, therefore are at the core of our recommendations. A credible process of peer review will be established to challenge the policy choices made within each jurisdiction and to ensure that measures applied on a country-by-country and SIFI-by-SIFI basis are consistent and mutually supportive. The third area is strengthened oversight and supervision. Senior line supervisors have drawn a frank assessment of weakness leading up to this crisis. These weaknesses were not present in equal amounts everywhere, but there is scope for improvements all around. Our recommendations in this area have been developed with the IMF. One set is focused on the mandates, independence and resourcing of supervisors. Another is on improved methods and practices to proactively identify and address risks. Fourth, we will be setting out higher robustness standards for core financial infrastructure. These infrastructures – including for central counterparties – are themselves sources of systemic risk were they to malfunction or fail. This is a complex project which will unfold over a number of years. It will need to be consistently implemented in all major countries to maintain a level playing field, avoid regulatory arbitrage and effectively address the risks to the overall system. The already established FSB framework of country and thematic peer reviewing process will address improved resolution frameworks and more intensive supervision In addition for SIFIs with the potential to create damages at a global level we will establish a mutual policy review process that will review and challenge the national policies towards major global SIFIs. Ahead of us, other issues still require attention: – So far, most of our attention has been on strengthening the resilience of the banking system, and rightly so. Yet, the shadow banking sector remains a large part of our financial systems, less regulated, but nonetheless significant in the credit intermediation and maturity transformation, and subject to runs in damaging ways. – We need to make frameworks for macro-prudential policies and systemwide oversight operational. We will be sharing approaches for surveillance, powers to obtain information and modalities for action on identified risks. The FSB will coordinate approaches where an international regulatory response is needed. We will be working with the BIS and the IMF to build principles for effective macroprudential policies. Lastly, the FSB is developing arrangements to broaden the involvement non-members in its work at early stages of policy development. We will be setting up regional arms of the FSB. Each regional group will be co-chaired by an FSB member and a regional non-member who will attend FSB Plenary meetings. Conclusions Let me conclude. Three things have been important in making the progress we have on reforms: First, the sheer seriousness of the crisis, and the recognition that, in a globally integrated system, we all sit in the same boat; Second, the readiness in the official community to agree objectives and timelines for substantial reform, including through the G20 process; and Third, the establishment of mechanisms, such as the FSB, to hasten the policy development needed to meet these objectives. I am quite confident that, with these, we will be able to achieve globally consistent rules that will lastingly increase the resilience of the financial system and the real economy and deliver the level playing field that a global system needs. | bank of italy | 2,010 | 10 |
Comment by Mr Ignazio Visco, Deputy Director General and Member of the Governing Board of the Bank of Italy, on "Sovereign bankruptcy in the EU: a comparative perspective", by Leszek Balcerowicz, Lectio Marco Minghetti 2010, Rome, 26 October 2010. | Ignazio Visco: Sovereign bankruptcy in the EU – a comparative perspective Comment by Mr Ignazio Visco, Deputy Director General and Member of the Governing Board of the Bank of Italy, on “Sovereign bankruptcy in the EU: a comparative perspective”, by Leszek Balcerowicz 1 , Lectio Marco Minghetti 2010, Rome, 26 October 2010. * * * While I retain full responsibility for the views put forward in this note, I wish to thank Raffaela Giordano for very useful suggestions. More than three years after the emergence of the financial excesses and regulatory failures that triggered a global economic crisis second only to that of the 1930s, its consequences are still to be fully understood and, especially, adequately addressed. In the aftermath of the Great Recession of 2008–09, we are left with a series of risks linked to the possible reemergence of global imbalances and associated turmoil in currency markets and to the huge accumulation of public debt in advanced economies, which could lead to higher borrowing costs and further financial turbulence if markets started to worry about its sustainability. The two risks are interrelated and are the subject of discussions within the G20 and in other venues. Serious sovereign debt distress has indeed materialized this year in a number of countries, in particular in the euro area, and issues such as debt resolution mechanisms and the design of fiscal rules have again come to the forefront of the policy debate in the European Union (EU). They are the subject of this most interesting lecture by Leszek Balcerowicz and I will deal with them sequentially. Sovereign debt distress resolution mechanisms Rather than focusing on the standard distinction between illiquidity and insolvency that may characterize situations of debt distress, Balcerowicz emphasizes that a sovereign default is most likely the result of unwillingness rather than inability to pay back a debt accumulated over time. This is a very reasonable starting point, as it is most likely that when structural reforms or macroeconomic adjustments that could help a country to regain solvency are not adopted, this is not for lack of possibilities but because they are deemed undesirable – the sovereign debtor prefers not to take on all the burden of the required adjustment – or socially and politically unfeasible – the government may not be able to pass and enforce the consolidation package. Indeed, governments are different from firms. While the latter are forced to go bankrupt when they do not have enough resources to repay their creditors, governments may choose to default on their obligations even though, in principle, they could always find ways to honour their debt by cutting expenditures and/or increasing revenues. Concerning the desirability of a default, however, as the IMF has recently pointed out 2 , a default is not an easy substitute for a painful fiscal adjustment. In fact, when the starting position of the defaulting country is a primary fiscal deficit, a marked move into a primary surplus is also required, as the country usually has no longer access to borrowing in the aftermath of a default. This would indeed be the case for many advanced economies today, for which the interest bill is not the main component of the deficit. Leszek Balcerowicz’s lecture is published in Italian and English by IBL Libri, Torino ([email protected], www.ibl-libri.it), and forthcoming in German in P. Behrens – Th. Eger – H.D. Schäfer (eds.), Ökonomische Analyse des Europarechts, Tübingen, Siebeck Mohr. Cottarelli, Forni, Gottschalk and Mauro (2010). I agree with Balcerowicz that the standard approach, treating the debt-distressed sovereign as a benevolent social planner maximizing social welfare in an infinite time horizon, is not appropriate. Different strategies to cope with a high-debt situation entail different redistributive consequences and social groups have often conflicting economic interests with respect to the policy to pursue in the midst of a debt crisis. The choice made by governments to cope with high public debts may therefore be better explained from a political economy perspective: the specific interests and relative political strength of different constituencies may definitely matter in such a choice. This approach can also help to explain the historically observed phenomenon that some countries are more likely to default than others; 3 to cite just one example, Argentina has defaulted three times since 1980. Moreover, most debt repudiation episodes in these defaultprone countries happened at what we would today consider relatively low levels of debt. At the end of 2001, for instance, when Argentina defaulted on the larger part of its public debt, the debt-to-GDP ratio was slightly above 50 per cent (though already 15 percentage points higher than three years earlier and 90 percentage points below its nominal value one year later, after the 1-to-1 peso-dollar parity had been abandoned). By contrast, there are countries and governments that can sustain much higher borrowing levels. A striking case is Japan, whose public debt recently reached 220 per cent of GDP without giving rise to significant market tensions. Several authors have argued that the degree of debt intolerance ultimately depends on the quality of a country’s institutions. In particular, sovereign default is often the outcome of a political struggle among different groups of citizens and is more likely to happen if domestic debt-holders are politically weak and the political price of the financial turmoil typically triggered by a sovereign bankruptcy is low. These conditions are in turn more likely to be present if a country lacks a politically strong middle class and/or a sufficiently independent central bank . As Balcerowicz remarks, in a world of financial liberalization the traditional distinction between domestic and foreign debt may not be that useful in explaining governments’ willingness to pay. While in the cases of Russia (1998) and Argentina the distribution of the public debt between resident and non-resident holders certainly did matter, with governments treating domestic creditors better than foreign ones, in the case of Turkey (also in 2001) default was not contemplated and the government took measures that helped to service the debt owned by both domestic and foreign creditors. It is worth noting that the share of public debt held by non residents has risen significantly in all European countries, owing to the integration of financial markets. However, not only the composition of debt holders but also other characteristics of the public debt matter in such circumstances. For example, a long enough maturity of government debt can make default avoidable, even for a country that records sizeable increases in yield spreads. The average cost of debt would react slowly, buying the country considerable time to convince the market of its solvency. It can be debated whether the existence of alternative sovereign debt resolution mechanisms can create different ex ante incentives, influencing the behaviour of sovereign debtors and their creditors. The lecture delves into the pros and cons of the Sovereign Debt Restructuring Mechanism (SDRM), a debt resolution mechanism, yet to be implemented, proposed in 2001 by Anne Krueger, then IMF First Deputy Managing Director. Balcerowicz concludes that the SDRM is functionally equivalent to the already existing debt resolution mechanisms, and says that more faith should be placed in the working of “pure market solutions”. However, he also seems to accept the notion that, as the SDRM is a more debtor-friendly mechanism, it could induce more fiscal discipline, strengthening the financial Cf. Reinhart, Rogoff and Savastano (2003). Cf. Giordano and Tommasino (2009). markets early warning function. In my opinion, this is not a secondary aspect. The key to an efficient approach to preventing sovereign distress lies in strengthening market pressure while also making it operate more gradually than is usually the case. An example is the Greek crisis. The spread between 10-year Greek and German bonds was less than 30 basis points in 2007. It widened to about 150 at the end of 2008 in the aftermath of the Lehman Brothers collapse and then fluctuated between 100 and 250 basis points until the beginning of this year. After that it skyrocketed, surpassing 900 basis points in the summer, and only in recent weeks has it fallen back somewhat to below 700. Of course, any institutional reform that forces governments to become more sensitive to the warning signals coming from financial markets is welcome. With the Stability and Growth Pact (SGP) the EU decided to use fiscal rules rather than market constraints, which were considered ineffective and slow in imposing fiscal discipline. As early as 1989, the Delors Committee had remarked that: “The constraints imposed by market forces might either be too slow and weak or too sudden and disruptive” 5 . A solid fiscal framework can improve budgetary coordination over time by removing the built-in bias towards fiscal profligacy that is often attributed to democratically elected governments. A medium-term fiscal framework is particularly important, especially in the current situation, which requires credible plans to anchor expectations and, at the same time, a degree of flexibility in implementation so as not to hamper economic growth. However, it does not follow from this that market forces necessarily have to work only ex post and continue to be “too slow and weak or too sudden and disruptive”. We must strengthen “gradual” market pressure. For that, I believe having pre-defined procedures for debt-restructuring and a well-designed crisis management framework would help greatly. Defaults are certainly “unnecessary, undesirable, and unlikely”, as Cottarelli et al. (2010) assert. But we should not only be ready in case they take place but also have institutions capable of conveying to the market the message that they are in fact possible. The sovereign debt crisis and the institutional setup in the EU I agree with the idea that what we ultimately need is a “strong representation of fiscally conservative voters”. But how can we implement this? In principle, by building a wide consensus on the advantages of fiscal discipline we may actually induce voters to punish policy-makers who do not deliver it. Asking voters to agree on fiscal consolidation packages without convincing them of their advantages is not straightforward. But well-designed, stable and easy to apply fiscal rules can contribute to the emergence of a public consensus in favour of policies aimed at fiscal sustainability. In the second part of his lecture Leszek Balcerowicz focuses on the problem of sovereign debt in the EU, analyzing three main aspects: (i) the management of the Greek crisis; (ii) the development of a debt resolution mechanism in Europe on the heels of the Greek experience; and (iii) longer term solutions for the stability of the euro area. According to Balcerowicz, a double standard emerged between euro- and non-euro countries in the EU. The vulnerable fiscal position of some euro-area countries led to the fear of contagion. After a lengthy debate and with a significant delay, the possibility of an IMF intervention was finally accepted. For non-euro countries, where the risk of contagion was considered modest, the application for IMF conditional loans was not controversial. In the case of euro-area countries, however, such as Greece, a complete set of intervention options was never put on the table; some options were not considered at all, basically due to motives of prestige. Committee for the Study of Economic and Monetary Union (1989), p. 20. With reference to the second point, Balcerowicz charges that the European Financial Stabilisation Mechanism (EFSM) is inconsistent with the letter of the Article 122.2 of the Treaty. He also criticizes the ECB’s Securities Market Programme as a possible threat to its reputation. Finally, turning to the analysis of long-term solutions, he advocates a proper institutional setting able to avoid pro-cyclical policies. Structural reforms should be implemented to spur long-run growth and to promote the adjustment of the economy to shocks. It is quite difficult to assess a single article of the Treaty out of context. The consistency of the EFSM with the letter of the Article 122.2 could be debated, but it is evident that the EFSM complies with the spirit of the Treaty, given the importance of the proper functioning of the EU and its very existence. Earlier this year, it was indeed conceivable that a debt crisis in a euro-area country could trigger a wider crisis involving other countries. Should a balance-of-payments crisis hit a member state, Article 143 of the Treaty governs mutual assistance. Hungary received support on this basis. A similar mechanism was missing in the context of economic and financial crises with impact on sovereign debt. The European Financial Stability Facility (EFSF), established in June by the Ecofin, fills the gap. The crisis has shown that the costs for the economy can mount quickly if crisis management is slow and if it is conditioned by political pressure in both the countries receiving and those providing financial assistance. It is now clearer than before that well-defined procedures need to be established to provide temporary financial assistance under clear and enforceable conditionality. The EFSF is an important step in this direction. In order to guarantee an incentive-compatible scheme, the EFSF has been associated with efforts in strengthening policy coordination in the EU. The crisis has confirmed that the reasons underlying the introduction of EMU fiscal rules (externalities of deficits and debts, pressure for bail out, moral hazard in fiscal policy) are still very relevant, as national rules and financial market discipline do not necessarily deliver sound policies. EU fiscal rules are warranted and should be strengthened. Under the European Commission proposal put forward at the end of September, compliance with rules and principles of the SGP is going to be reinforced by speeding up the Excessive Deficit Procedure and giving more prominence to public debt and sustainability criteria. The broader surveillance of euro-area macroeconomic and competitiveness developments makes it possible to focus on structural issues. The involvement of the EU in developing the ex ante dimension of budgetary and economic surveillance is based on the assumption that prevention can be more effective than correction. Sanctions can play a role in dampening the relative convenience of profligate fiscal policies, but a system of early peer-review of national budgets could detect inconsistencies and emerging imbalances at an early stage. The Van Rompuy task force too will soon publish detailed proposals. It is important that the European Council rapidly evaluate these proposals, jointly with those of the Commission, and come up with an effective decision that tackles the two main weak points of the SGP (in both the 1997 version and the 2005 revision): (i) the absence of incentives and sanctions for fiscal behaviour in good times, and (ii) the lack of an independent enforcer of EU rules. Sanctions have been highly uncertain, as EU Council members were supposed to fine each other via lengthy procedures involving discretionary steps that would lead to theoretically large, but actually unlikely, pecuniary sanctions. Reforms such as the interest bearing deposits and the European semester aim at tackling the first problem. A greater automaticity in procedures, the reduction of EU funds and, possibly, the loss of voting rights would help in tackling the second problem. National fiscal rules and procedures can also help to pursue fiscal consolidation and anchor fiscal expectations. The 2009 reform of the German fiscal framework sets an important benchmark. 6 Other countries may decide to assign a greater role to expenditure rules and to independent fiscal authorities. With respect to the proposals advanced to make the debt criterion operational, the Commission’s suggestion of allowing excessive deficit procedures for insufficient debt reduction (vis-à-vis an annual 1/20 reduction of the excess over the 60 per cent standard for the debt-to-GDP ratio over a three-year period) has been praised for its automaticity as well as its simplicity. It has been argued that “the practical translation” of the debt principle is “elegant, but short-termist”, even if this “way of turning around the 60% nonsense is undoubtedly clever”. There is no question, however, that a consistent and progressive reduction of the current high debt levels over the cycle is absolutely necessary; they are a major constraint on our countries’ adjustment possibilities, especially in the event of shocks that could have irreversible consequences (due either to the unwillingness to pay or to the socio-political unfeasibility discussed by Balcerowicz). In this perspective, it seems beside the point at this stage (and impossible given the letter of Treaty) to question the reference standard, as well as the speed of convergence, even if we may readily acknowledge that “business cycles usually extend over more than three years”. The debate on how to cope with the accumulation of public debt following the crisis has led – inter alia – to some proposals for European countries to pool their debt at least up to a certain level (60 per cent of GDP) 9 or to pool in a fund operating in the market (and possibly financed with a levy on financial transactions) the share of their debt directly tied to rescuing the financial system (a proposal not limited, in this case, to the EU). 10 Both types of proposal are interesting and may improve market liquidity. The first would be especially directed at reducing the burden of debt, the second at offsetting the negative consequences of debt accumulation related to the financial crisis. They leave, however, significant open questions. To mention only a couple: (i) it may be hard to reach a consensus on the definition of the share of debt that has to be pooled; (ii) countries having debt substantially in excess of such a share may face a bond market liquidity problem. In addition, these proposals pose problems in terms of incentives to participate for countries with lower debt and higher credibility (typically Germany) and with less debt directly tied to rescuing the financial system (typically Italy). More generally, these schemes imply some cross-subsidization which is hard to price, even though in the case of the establishment of a fund, profits may be used to progressively compensate different country contributions. But we should be aware that weak fiscal positions are not the only source of the tensions on sovereign debt. In 2007 Ireland and Spain recorded fiscal surpluses (respectively 0.3 and 1.9 per cent of GDP) and had relatively low public debt-to-GDP ratios (25 and 36 per cent, respectively). This suggests, as Balcerowicz also acknowledges, that standard fiscal indicators are not sufficient. Moreover, a tighter fiscal policy can sometimes help, but it is not a panacea for macro imbalances. The European Commission now suggests introducing a new Excessive Imbalances Procedure. It will comprise the regular assessment of the risks of imbalances based on a scoreboard composed of several economic indicators. Indicators of both the external position of the economy (e.g. current accounts, external debt, real effective exchange rates) and of the internal situation (e.g. private, as well as public, sector debt) See Franco and Zotteri (2010). Wyplosz (2010). Ibidem. Cf. Delpla and Von Weizsacker (2010). V. Visco (2010), and, for a similar proposal that contemplates the transfer of such debt in excess to an international institution such as the IMF, Savona (2010). should be considered. The proposal, though important, faces three difficulties: first, detecting macroeconomic imbalances may not be simple; second, identifying appropriate policies to address structural problems is not straightforward; third, putting pressure on a country from Brussels can be politically difficult when all seems to be going well. This is an area in which national independent authorities could have a role. A very important issue concerns the lessons we have learnt from the crisis for the design and the conduct of our monetary policy, as well as for its interactions with macro-prudential policies. If anything, the crisis has confirmed that we should firmly stick to our objective to deliver price stability in the medium term. Indeed, the credibility of the Eurosystem in pursuing this objective was crucial in allowing us to adopt exceptional measures without compromising the anchoring of inflation expectations. The crisis has also shown how important it is to interpret credit and money developments properly and take them into account in our decisions, in particular by “leaning against the wind” in case of credit booms and asset price imbalances. This is embodied in the Eurosystem setup, insofar as the careful monitoring of monetary and credit aggregates helps to identify risks both to financial and price stability. A crucial issue is how to detect the accumulation of systemic risk in time. I am confident that the new framework based on the ESRB will provide a fundamental contribution in this respect. Enhanced interaction among macro-prudential bodies, between them and the micro-prudential authorities, and between macro-prudential and monetary policy authorities will be crucial. With reference to the ECB’s Securities Market Programme, suffice it to say that developments in financial markets called for special interventions. The programme is in line with the shared principles of European monetary policy-making and does not represent a change in the monetary policy stance. The current financial crisis has been described as valuation crisis. In fact, bond spreads for several euro-area countries widened beyond any reasonable level, and severe tensions in the bond market hampered the monetary policy transmission mechanism, demanding action by the central bank. However, a very important and more immediate issue is the exit from the exceptional monetary policy measures that have been adopted. All the various non-conventional measures that central banks, including the ECB, have taken over the last years have been directed at avoiding a financial and economic collapse. That collapse has not materialized. The relevant issue now is the timing and speed of the exit from these measures. This will have to be guided, on the one hand, by the need to maintain support for the orderly functioning of the money and financial markets and to sustain credit flows to the economy, and, on the other hand, by the need to avoid introducing distortions into the system and sowing the seeds of future imbalances. In the euro area, our “credit enhancing” policy was almost entirely based on temporary refinancing to the banking system and can easily be unwound. Indeed, gradual phasing out has started with the maturity of the six-month and twelve-month operations. The speed with which the exit will proceed will depend on how quickly financial markets get back to normality, on the pace of the economic recovery, on banks’ ability to obtain stable funding from private capital markets. Finally, as Balcerowicz forcefully argues, an adequate response to debt distress requires to counter with decision the ongoing erosion of fiscal discipline. Structural reforms that are perceived as capable of enhancing a country’s adjustment possibilities, such as those that would lead to the removal of unnecessary administrative barriers, a higher efficiency of public services and a substantial improvement of the education system, are also of fundamental importance. Furthermore, in the market perception what matters most for debt sustainability is the ability to implement specific initiatives, capable of affecting the medium- to long-term growth possibilities of a country as well as the trends in its public expenditures, rather than the (ephemeral) short-term flexibility of its (nominal) exchange rate. This is what is shown, inter alia, by the Italian experience of 1992–95, when the adoption of a critical pension reform was what really mattered to convince markets of the return to a sustainable trend in public finances. References Committee for the Study of Economic and Monetary Union (1989), Report on the economic and monetary union in the European Community, Brussels. Cottarelli, C., L. Forni, J. Gottschalk and P. Mauro (2010), “Default in today’s advanced economies: Unnecessary, undesirable, and unlikely”, IMF Staff Position Note, 10/12, September. Delpla, J. and J. Von Weizsacker (2010), “The blue bond proposal”, Bruegel Policy Brief, 2010/3, May. Franco D. and S. Zotteri (2010), “Fiscal rules: What lessons from Germany?”, mimeo, Banca d’Italia. Giordano, R. and P. Tommasino (2009), “What determines debt intolerance: the role of political and monetary institutions”, Temi di discussione, 700, Banca d’Italia, January. Reinhart, C., M.K. Rogoff and M.S. Savastano (2003), “Debt intolerance”, Brookings Papers on Economic Activity, 1. Savona, P. (2010), “Un parcheggio per i debiti pubblici del mondo”, Il Messaggero, 18 febbraio. Visco, V. (2010), “Come salvarsi dalla deflazione”, Il Corriere della Sera, 13 luglio. Wyplosz, C. (2010), “Eurozone reform: Not yet fiscal discipline but a good start”, Vox, 4 October. | bank of italy | 2,010 | 11 |
Address by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the 86th World Savings Day, Rome, 28 October 2010. | Mario Draghi: 2010 World Savings Day Address by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the 86th World Savings Day, Rome, 28 October 2010. * * * The international economy three years after the start of the crisis The recovery and international cooperation Economic recovery is strong in the emerging countries, weak in the United States and uneven in the euro area. Economic policy responses have differed. Monetary policies have remained expansive everywhere, but while in the euro area there is now talk of tightening, in the United States a further expansion of liquidity through Federal Reserve purchases of treasury paper has been announced. In Europe budgetary policies are now clearly directed at containing deficits and reducing debt; this is not the case elsewhere. Some countries are making foreign exchange interventions to support their exports. International payments imbalances are beginning to widen again; currencies with marketdetermined exchange rates are being affected by the policy differences and the resulting speculative pressures; global recovery is at risk. The only answer is for the main countries to coordinate their economic policies more closely. Some commitments were made at the last meeting of the G20: to pursue structural policies to support global demand; to keep current account imbalances within sustainable limits; to forgo all forms of protectionism; to move towards flexible exchange rates more consistent with the fundamentals, while working to reduce the volatility of capital flows to the emerging countries; and, in the advanced countries, to draw up budget consolidation programmes for the medium term that are credible and promote growth. These are not rhetorical conclusions, but follow from a hard-won recognition of the inevitability of collective action. Financial regulation Where this action is already taking the greatest steps is in the construction of a global system of financial regulation. The driving force is to be found within the G20; the reform of the Basel rules is a milestone. The new rules introduce a definition of bank capital that is common to all countries; they provide for a significant increase in both the level and the quality of this aggregate; they limit financial leverage, counter liquidity risks, and mitigate the procyclical trends inherent in financial intermediation. In comparison with the rules in force, those that have now been defined are innovative on several fronts and incisive. At the same time, they will be applied gradually to ensure that banks can continue to operate smoothly and that firms and households do not suffer from credit restrictions. To make the transition to the new rules easier for banks, the Bank of Italy will set up a help desk to explain how the rules are to be interpreted and to ensure that intermediaries implement management policies consistent with achievement of the new requirements. Basel III will make the banks stronger, but it does not address the question of the risks posed by Systemically Important Financial Institutions (SIFIs), whose size or presence in the most important financial nerve centres means they would be rescued at any cost if they were about to fail. At the next G20 summit, the Financial Stability Board will submit a set of proposals for the creation of an institutional and regulatory environment within which SIFIs will be better able to absorb very large losses without going into a full-blown crisis and governments can allow them to fail when necessary. These proposals, endorsed by G20 Finance Ministers and Central Bank Governors at the recent meeting in Seoul, are based on four pillars: i) Institutional arrangements should be adopted in all countries that will allow SIFIs to be resolved without the global financial system running severe risks and without having recourse to taxpayer money, as happened for the desperate rescues of the last few years. The national laws that hinder international cooperation today must be amended; agreements between home and host authorities must be drawn up, with roles and responsibilities clearly defined. Under Italian law the Bank of Italy already has sufficient instruments at its disposal; only a few adjustments will be required to transpose the international recommendations. In particular, the supervisory authority must be empowered to set up bridge banks to which the assets and liabilities of a troubled institution can be temporarily transferred, to ensure continuity of operations pending its disposal on the market. ii) SIFIs, especially those operating at global level, will need to have capital or other instruments equally capable of absorbing losses available in amounts greater than those laid down by the Basel III standards. Shareholders – and in some cases bondholders as well – must be asked to shoulder some of the losses in difficult times; among other things this would strengthen both market discipline and investor scrutiny of management decisions. It is therefore possible to envisage the introduction of more severe capital requirements than those imposed on non-systemic intermediaries, debt instruments that would automatically convert to capital when banks’ ratios fall below a certain safety threshold (contingent capital), reductions (haircuts) for some creditors in the face value of debt during a crisis (bail-in). iii) Supervision of SIFIs needs a broader mandate ensuring greater independence of supervisors, enhanced resources and powers consonant with the degree of complexity of the supervised institutions. iv) The trading of the derivative products that can be standardized must take place on regulated markets or platforms with central counterparties, supervised by the authorities and having adequate capital and organizational resources. Trade reporting for all products must be channelled to trade repositories that the authorities can access, including for economic policy purposes. The FSB will also submit proposals on another issue raised by the recent financial crisis: the role and function of credit rating agencies. The importance of external ratings for regulatory purposes must be gradually reduced. It is not a question of denying their general validity, but rather of addressing the most obvious drawbacks associated with their mechanical application, in terms of systemic procyclicality and potential destabilization of markets. Italian banks and the supervisory authority Banks’ situation and performance The results of the stress tests for the European banks published on 23 July 2010 confirmed the high degree of resilience of the major Italian banks to scenarios prefiguring not only macroeconomic decline but also a significant increase in sovereign risk. From the beginning of April to yesterday, CDS premiums for the three largest Italian banks rose by 63 basis points, reflecting the increase in those on sovereign debt. The Italian banks, together with their Spanish counterparts, are the only ones in the euro area to have maintained premium levels lower than those on sovereign debt. However, the increase weighs on the cost of long-term fund raising, at a time when large volumes of bonds are nearing maturity. It is important that the maturity structure of banks liabilities not be unduly tilted towards the short term, increasing the vulnerability of their liquidity position, which up to now has remained balanced in even the most severe phases of the crisis. As of June, the resources of the five leading Italian banking groups best able to absorb losses (core tier 1 capital) had reached on average 7.7 per cent of their risk-weighted assets, 1.2 points more than in June 2009 and 2 points more than at the end of 2007. Compliance with the new rules imposing a higher standard of quality, a minimum requirement of 4.5 per cent for core tier 1 capital, and an additional buffer of 2.5 per cent will also make it necessary for Italian banks, above all the large ones, to strengthen their capital base significantly, although the time allowed to make the adjustment will mitigate the severity of the reform. Italian banks are not at a disadvantage internationally: the requirements have been tightened even further for trading in securities and derivatives, which generate less business in Italy. As regards lending to small and medium enterprises, the preferential treatment already applying to the calculation of capital adequacy will remain in place. The capital of the smaller banks, which are the main ones serving SMEs, is already well above the new regulatory requirements. International studies indicate that the macroeconomic cost of adapting to the new rules will be more than offset by the benefit of a lesser likelihood of new systemic crises. Our fiscal treatment of write-downs and losses on loans has encouraged the setting up of balance-sheet provisions that do not entirely qualify as capital under the new Basel III rules. We must work towards finding a solution to this problem in the coming months, one that combines the need to prevent an evident competitive disadvantage for our intermediaries with the need to safeguard the public finances in the medium term. Like other banking systems founded on the traditional business of intermediation, our banks are also experiencing a decline in profitability. In the first half of this year the average ROE of the five leading Italian banks fell to 4 per cent, one percentage point lower than in the same period of 2009. Trading and investment banking contribute less to profits than in some of the other European groups. Profit and loss accounts, already affected by low interest rates and small volumes of business, now also have to cope with a significant deterioration in loan quality. We will be careful to ensure that banks’ provisioning policies take account of the delicate nature of this phase, to ensure that internal models for assessing asset quality pick up tensions and internal stress tests are promptly updated. It is imperative, in order to support profitability, to take action on costs, which are higher in relation to income than the European average. The temptation to resort to strategies entailing excessive risks or to demand exorbitant commissions from clients who are less well-informed or in difficulty must be avoided. In the months to come, if the pick-up in lending we now see proves lasting, it will support interest income. Not long ago, Italian banks demonstrated that they were able to boost revenue by increasing the range and quality of the services they offered, improving their riskassessment procedures and raising the level of their operating efficiency. This course must be resumed. Only by taking action on several fronts will it be possible to achieve levels of profitability that allow the system’s capitalization to be increased while ensuring the ability to finance the economy. Banks’ governance and the role of the foundations More than two years have passed since the Bank of Italy, anticipating international developments, laid down rules on banks’ governance. Adequate debate and collegiality in taking strategic decisions, unity of managerial approach in running the business and an effective and aggressive structure of controls at every level are the essential elements of sound and prudent management. I take this occasion to underscore some guidelines for action in this field. The Bank of Italy does not interfere improperly with entrepreneurial autonomy. It does not pretend to dictate specific internal structures, especially for the largest and most complex banks. However, it does consider it necessary, whatever the structure chosen, that the chains of reporting and command be established unambiguously, that effective flows of information to and from the top be ensured, and that the responsibilities of the governing bodies and the individual managerial levels be set down in a transparent manner. One of the clearest lessons of the crisis is that the risk management function in banks must cover all strategies and transactions, dialogue authoritatively with the lines of business at every level, report directly, promptly and thoroughly to top management and the corporate management bodies. The corporate officers of banks with control tasks, who have particularly sensitive functions, must have professional expertise adequate to the complexity of assets and risks. The obligation to inform the Bank of Italy of every fact that might affect sound and prudent management must be complied with, on pain of sanctions. The delicate, specific responsibilities of directors and members of the control bodies of banks require adequate time and commitment. With this in mind, it is advisable to consider the possibility of rules limiting multiple office-holding. The Italian experience of banking foundations is positive, not only for the important contribution they make to socially commendable activities, but also for the role they have played as stable, solid shareholders in banks; a role filled in other countries by institutional investors, which are rare in Italy. During the crisis, the foundations’ long-term view of banks’ prospects and their roots in the territory – factors driving development at local, regional and national level – were crucial. When other shareholders, such as investment funds, until the eve of the crisis so vociferous in demanding efficiency gains and changes of management, vanished, often for good, it was the foundations that subscribed for the repeated capital increases that made it possible to weather the storm unscathed. Just as the future promises to be challenging for banks, it will be challenging for their largest shareholders as well. The foundations will have to act on three key fronts: their own governance, the recapitalization of banks and self-discipline in their relationship with banks’ managements. For the action of banks’ control bodies to be adequate, it is necessary that the boards of their main shareholders, which help to elect them, be equally adequate. For the reasons described earlier, they will be asked to make a significant effort to strengthen banks’ capital, an effort to be faced without flinching. The foundations must continue to take a long view; they must understand that they cannot sacrifice the prospects of their banks and the economies they serve to the desire for immediate monetary returns, which, besides, are now harder to obtain. The Italian experience of public banks is vivid in our memory. Certain relationships between local economic groups, public banks and politics ultimately proved disastrous for the banks and deleterious for civic mores; in more than one case, local development was hindered rather than helped. With great, conscious effort we worked our way free of this logic twenty years ago; other countries now look to the Italian experience. No one wants to turn back. Growth and employment While the Italian banking system may have withstood the global financial crisis of 2007–08 better than others, the recession that it provoked was especially severe in our country, driving annual output in 2009 down to the level of nine years earlier. And as we have seen, the difficulties of households and firms are now having repercussions on banks. But the recession does not appear to have halted the modernization of the productive system that we began to see towards the middle of the decade. The forecasts for GDP growth this year and next are scarcely 1 per cent. In the first half of this year economic activity benefited from the expansion of exports, which are now slowing. Economic growth needs the contribution of domestic demand: the virtuous circle in which advanced models of consumption and farsighted investment lead to high and widely distributed incomes, hence further consumption and well-being. Consumer spending is stagnating today because the real incomes of households are not rising and there is widespread uncertainty about the future. The central issue is the state of the labour market, which needs to be analyzed considering all the available indicators and reliable sources of information. The number of people in work in Italy fell by 560,000 between the second quarter of 2008 and the fourth quarter of 2009, largely among fixed-term and part-time employees and persons who are formally self-employed but in almost every way have the characteristics of wage-earners. The first half of 2010 saw a sluggish recovery, with a gain of 40,000 jobs. As in other European countries, the impact of the recession was attenuated by large-scale resort to short-time programmes. Between September 2008 and August 2010 a total of 1.8 million hours of Wage Supplementation were authorized, equivalent to about half a million full-time workers each year. From the onset of the crisis, the Government extended eligibility for these benefits to additional workers. The unemployment rate has reached 8.5 per cent of the labour force, including off-the-books workers. For a fuller assessment of the state of the labour market, many national and international statistical agencies also use other measures of underutilization of labour. In addition to the officially unemployed, such measures also count workers on short-time programmes like Wage Supplementation, discouraged workers (those who want jobs and are available to work but have given up active search for a job because they have lost hope of finding one), and those who have part-time but want full-time jobs. In Italy, counting only the first two of these categories, the labour underutilization rate is above 11 per cent of the potentially employable, about the same as in France and higher than in the United Kingdom and Germany. * * * Italy faced the crisis with a budget deficit still close to 3 per cent of GDP and a public debt that, though gradually diminishing, was still high by international standards. The response to the crisis was prudent, and the repercussions on the public finances were smaller than in other countries, thanks in part to the absence of bank bailouts. If fully implemented, the measures of the three-year public finance package approved in July, curbing current expenditure and reducing tax evasion, could bring the debt ratio back onto a downward path. The euro-area countries have responded to the recession of recent months both individually, with fiscal policy measures designed to contain sovereign risk and prevent contagion, and collectively, with new institutions and rules. This demonstration of cooperation, solidarity and firm resolve has consolidated the euro. Though the process has not yet been completed, it has shown that the countries with the weakest public institutions are not in a position to overcome their economic policy difficulties on their own. With European rules that are quasi- automatic, fast-acting and sensitive to market signals, they draw on the stronger countries for the determination they themselves lack. Much has been done in controlling deficits on the front of the public finances, but the fundamental pillar of financial stability is economic growth, without which debts will not be repaid. This is the front on which the Union’s cohesion will be tested: the ability to foster harmonious, rapid, sustained growth embracing all the member states, with common rules that, like those governing the public finances, help the countries lagging behind in undertaking the structural reforms needed if they are to return to faster growth. | bank of italy | 2,010 | 11 |
Remarks by Ms Anna Maria Tarantola, Deputy Director General of the Bank of Italy, at the 58th World Forum for Women Entrepreneurs Femmes Chefs d'Entreprises Mondiales - FCEM World Congress, Florence, 22 October 2010. | Anna Maria Tarantola: Women nurturing sustainable development Remarks by Ms Anna Maria Tarantola, Deputy Director General of the Bank of Italy, at the 58th World Forum for Women Entrepreneurs (Femmes Chefs d’Entreprises Mondiales – FCEM) World Congress, Florence, 22 October 2010. * * * I would like to thank the President of AIDDA, Laura Frati Gucci, for inviting me to the 58th FCEM World Congress in this conference entitled “How Women Face the New Economy and Ecology”. The goal of the conference, to assess women’s contribution in balancing economic growth and natural resource conservation, is both topical and challenging. This is not the first time I find myself considering human-ecosystem interaction: natural resources are a fundamental input for production and consumption; the environment is the receptacle for the waste generated by these processes. 1 The fundamental question we must address today is how to increase and spread wealth and wellbeing while respecting and protecting the environment. The role of women is central. Throughout history, women and nature have been closely linked: in Ayurvedic philosophy, prakriti – nature – is symbolized by a woman; similarly, the idea of “mother earth” is common to many Indo-European cultures. Perhaps it is no accident that so many of those who have contributed to raising our environmental consciousness have been – and are – women. Let me mention four of these outstanding women. The biologist Rachel Carlson was the first to study the harmful effects of DDT in the early nineteen-sixties. She can be considered the founder of the modern environmental movement. She was a scientist who stood behind her findings despite fierce attacks from the chemical industry lobby. 2 The environmental scientist Donella Meadows co-authored the book Limits to Growth 3 which laid the foundations for an analysis of the Earth’s limited capacity to support economic and demographic growth. This report was criticized – in particular by economists 4 – but without doubt it had a profound impact on the analytical method used to study environmental problems. Meadows used computer technology to apply the theory of complex systems to the economic analysis of the reciprocal effects of growth and the environment; this is now the standard method to analyse the economic effects of climate change (Integrated Assessment Modelling). The Nobel Peace Prize winner Wangari Maathai, an activist and founder of the environmental movement Green Belt, contributed importantly to the reforestation of vast areas of Kenya. 5 Reforestation not only plays a primary role in combating desertification, ensuring that soil retains its nutrients and water resources, but it is also an essential tool for reducing greenhouse gases. 6 Tarantola A.M. (2010), Crescita economica, benessere e sostenibilità della domanda di energia, remarks addressed to the Istituto Giuseppe Toniolo di Studi Superiori, Naples, 20 January. www.rachelcarson.org. Meadows D.H., Randers J., Meadows D.L. and W.W. Behrens (1972), The Limits to growth: A report for the Club of Rome's Project on the Predicament of Mankind. Nordhaus W.D. (1992), Lethal Model 2: The Limits to Growth Revisited, Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 23. www.greenbeltmovement.org. About one-fifth of green house gas emissions are linked to deforestation. As a result, reforestation has become a means of reducing the concentration of climate-altering gases, and whose centrality is witnessed by Maathai demonstrated that managing common resources, such as the environment, does not necessarily have to lead to over-exploitation, to the “Tragedy of the Commons” as prophesied by Garrett Hardin. The economist Elinor Ostrom found evidence to support this outcome in her research on institutional economics. Ostrom was awarded the 2009 Nobel Prize in Economic Sciences, the first woman ever to win in this category, for her work on economic governance. 1. Women and the environment in developing countries In industrialized countries, women have made important contributions in raising our environmental consciousness. In developing countries, however, where rural communities are still prevalent, women remain in a condition of profound dependency on their surrounding environment; women are often responsible for activities essential for family subsistence: collecting water and firewood and working in the fields. 7 For this reason, environmental degradation, and the effects of climate change on the availability of water resources and crop yields, particularly hurt women. Migration owing to climate change, 8 which primarily affects men, further increases the burden of toil for women. Moreover, women and children account for the majority of victims in environmental catastrophes, 9 the frequency of which could increase in the future because of global warming. It is emblematic that the Millennium Goals place side-by-side the objectives of gender equality and a development model for the sustainable use of natural resources. Women are therefore the ideal interlocutors for the adoption and dissemination of sustainable practices and it is precisely because of their sensibility that Agenda 21 for the promotion of sustainable development recommends increasing “[…] the proportion of women decision makers, planners, technical advisers, managers and extension workers in environment and development fields”. A prerequisite for increasing female participation is improving conditions overall for women. A World Bank study shows that in countries where women are better educated, there is greater success adapting to the negative effects of climate change. 10 Indicators from the Global Gender Gap, referring in particular to economic participation and opportunity, on the one hand, and political empowerment on the other, show depressingly low figures for women in Sub-Sahara Africa, the Middle East, and North African countries (below 0.5 with reference to economic participation, 0.2 with reference to political empowerment) and reveal an enormous disparity with respect to men. 11 the United Nations’ Program for Reducing Emissions from Deforestation and Forest Degradation (UNREDD) – which aims to make it more economic to conserve and manage forest resources correctly than to deplete them. A review can be found in the volume published by UNEP (United Nations Environmental Program), 2004, Women and the Environment. Tarantola A.M. (2009), Economia solidale e sviluppo sostenibile nell’era della post globalizzazione, remarks addressed to the Fondazione Sorella Natura, Rome, 26 June. In the recent tragic flooding in Pakistan, 85 per cent of the victims were women and children. Mandelbaum J., The female victims of Pakistan's flood, Salon, 20 August 2010 (www.salon.com/life/broadsheet/2010/08/20/pakistan_floods_women_victims_open2010). World Bank (2010), Adaptation to climate extremes in developing countries: the role of education. World Economic Forum (2010), The Global Gender Gap Report 2010. 2. The industrial world: a green economy led by women? In industrialized countries, the availability of high quality forms of energy has greatly reduced the amount of time and effort that women must dedicate to housework. Women here no longer are required to interact directly, and on a daily basis, with the environment to meet family needs. Nonetheless, there is substantial evidence that women are more sensitive to environmental matters. According to OECD research, the most environmentally-aware consumers are women. They are more likely than men to recycle domestic waste, buy organic food and green products, and place greater value on fuel-efficient means of transport. 12 These results are confirmed by other studies. A survey conducted by Eurobarometro found that in 2007 the share of women who said they had done something to improve the environment was six percentage points higher than for men; the International Social Survey Programme’s 1993 study of attitudes to the environment found, in the sample of countries surveyed, a large gap between women and men in terms of willingness to pay more for ecofriendly consumer goods, particularly in Italy, Australia and Norway. 13 Recent behavioural studies give further support to these results. 14 Can this greater willingness to consider the effects of one’s actions on the environment be integrated in the transformation process that is “greening” our economies? In brief, does the green economy represent an opportunity to capitalize on the strong bond between women and nature? The answer is yes – but only if the necessary policies are implemented to ensure that this opportunity is realizable and we can reap the dual dividends of more sustainable, less discriminatory, economic growth. For this to happen, actions must be taken to increase women’s presence in the work force in general and in the green economy in particular. The Lisbon agenda indicated the affirmative action that should be taken to prevent discrimination against women in their professional development. Among these, those making it easier for women to combine career and family are particularly important. For example, a study of the development of the photovoltaic sector in Southern Italy underlines the fact that despite very high female employment potential (among recent architecture graduates, women outnumber men), the realization of this potential could be blocked by the lack of preschool facilities for young children. 15 Other measures relate specifically to the possibilities offered by the new green sectors with the greatest growth potential (renewable energy, construction techniques, and agricultural biomass). In these sectors, women represent a very small part of the total work force and they rarely hold the top positions. 16 This is due primarily to cultural factors, which have perpetuated a high level of segregation in these industries. Even in traditional energy sectors, female participation is extremely low – 14 per cent according to the latest survey of firms. OECD, Survey on Household Environmental Behaviour, 2008. The data can be consulted online at zacat.gesis.org/webview/index.jsp. Czap N. and H.J. Czap (2010), An experimental investigation of revealed environmental concern, “Ecological Economics”, vol. 69. Barboni A. (2009), Women Workers in the Photovoltaics Industry in Southern Italy, a study prepared for the previously cited Sustainlabour report. A joint UNEP-Sustainlabour study estimates that fewer than 1 per cent of top managers in the energy industry are women. Sustainlabour (2009), Green Jobs and Women Workers, Draft Report. In the future, the fact that only a small number of women pursue advanced degrees in the sciences could penalise their access to the green economy. In Italy, only 17 per cent of women under the age of 44 have taken a scientific degree course at university (compared with 39 per cent of men); almost twice as many study the humanities. It is essential to launch a comprehensive information campaign to guide women’s choices towards the subjects that have the greatest employment potential, breaking the vicious cycle of segregation in the traditional energy sectors. Women must have the opportunity to play a leading role in developing the green economy. It would be ironic indeed if the growth achieved with the development of the green economy actually increased the employment gap between men and women. 3. Conclusion Women have a unique and strong bond with nature. This can and must be used as a stepping stone to design policies for sustainable development. We must aim to reconcile economic welfare, the conservation of natural resources, and environmental quality. We cannot afford to lose this opportunity to paint the green economy pink. To achieve these goals, however, women must be enabled to provide their contribution. The weight of women in politics, in institutions and throughout the business world must be increased, including at the top levels. For this to happen, a joint effort is required by all stakeholders – politicians, firms, trade unions, civil and cultural leaders, the media – and women themselves. A more efficient use of female resources in the labour market and a higher presence of female entrepreneurs can help us to pursue a more sustainable and more equitable economy, more attentive to the needs of the environment and of human beings themselves. In less developed countries, policies aimed to ensure women greater freedom of action (such as access to education and the right to vote) 17 can help contrast the adverse impact of climate change, for example through mitigating measures (such as reforestation) and enabling ecosystems to be more resilient to higher temperatures (for instance, through the management of land and water resources to prevent desertification). In industrialized countries, women’s greater eco-awareness places them in an ideal position to actively participate in setting policies that can attenuate the utilization of natural resources and limit the harmful effects of consumption and production on the environment. The presence of a greater number of women entrepreneurs in innovative sectors, such as the green economy, is also key to achieve these goals. Even simple actions can help to reduce our impact on the ecosystem: conservation of resources (by water and energy saving) and pollution control (for example, more ecofriendly means of transport and producing less household waste). The literal meaning of economics is “household management” and women have traditionally been the frugal, pragmatic, responsible and farsighted managers of home and family. The same can be true for the environment – home to us all. Almost twenty years ago, the Rio Declaration proclaimed that “Women have a vital role in environmental management and development. Their full participation is therefore essential to achieve sustainable development”. Now is the time to translate this declaration into action to ensure a better, fairer and more sustainable future, for all of us and for generations to come. Amartya Sen sees this extension of freedom, and not just greater physical wellbeing as the key to overcoming women’s subordination in the less developed countries. The same conclusions can be extended to the socially excluded in the developed countries. Sen A. (2001), Development as Freedom, O.U.P., 1999. | bank of italy | 2,010 | 12 |
Comments by Mr Ignazio Visco, Deputy Director General of the Bank of Italy, on the lecture by Mr Leszek Balcerowicz on "Sovereign bankruptcy in the EU - a comparative perspective", at the Lectio Marco Minghetti 2010, Rome, 26 October 2010. | Ignazio Visco: Comments on Mr Leszek Balcerowicz’s lecture “Sovereign bankruptcy in the EU – a comparative perspective” Comments by Mr Ignazio Visco, Deputy Director General of the Bank of Italy, on the lecture by Mr Leszek Balcerowicz on “Sovereign bankruptcy in the EU – a comparative perspective”, at the Lectio Marco Minghetti 2010, Rome, 26 October 2010. * * * While I retain full responsibility for the views put forward in this note, I wish to thank Raffaela Giordano for very useful suggestions. Leszek Balcerowicz’s lecture is published in Italian and English by IBL Libri, Torino ([email protected], www.ibl-libri.it), and forthcoming in German in P. Behrens – Th. Eger – H.D. Schäfer (eds.), Ökonomische Analyse des Europarechts, Tübingen, Siebeck Mohr. More than three years after the emergence of the financial excesses and regulatory failures that triggered a global economic crisis second only to that of the 1930s, its consequences are still to be fully understood and, especially, adequately addressed. In the aftermath of the Great Recession of 2008–09, we are left with a series of risks linked to the possible re-emergence of global imbalances and associated turmoil in currency markets and to the huge accumulation of public debt in advanced economies, which could lead to higher borrowing costs and further financial turbulence if markets started to worry about its sustainability. The two risks are interrelated and are the subject of discussions within the G20 and in other venues. Serious sovereign debt distress has indeed materialized this year in a number of countries, in particular in the euro area, and issues such as debt resolution mechanisms and the design of fiscal rules have again come to the forefront of the policy debate in the European Union (EU). They are the subject of this most interesting lecture by Leszek Balcerowicz and I will deal with them sequentially. Sovereign debt distress resolution mechanisms Rather than focusing on the standard distinction between illiquidity and insolvency that may characterize situations of debt distress, Balcerowicz emphasizes that a sovereign default is most likely the result of unwillingness rather than inability to pay back a debt accumulated over time. This is a very reasonable starting point, as it is most likely that when structural reforms or macroeconomic adjustments that could help a country to regain solvency are not adopted, this is not for lack of possibilities but because they are deemed undesirable – the sovereign debtor prefers not to take on all the burden of the required adjustment – or socially and politically unfeasible – the government may not be able to pass and enforce the consolidation package. Indeed, governments are different from firms. While the latter are forced to go bankrupt when they do not have enough resources to repay their creditors, governments may choose to default on their obligations even though, in principle, they could always find ways to honour their debt by cutting expenditures and/or increasing revenues. Concerning the desirability of a default, however, as the IMF has recently pointed out 1 , a default is not an easy substitute for a painful fiscal adjustment. In fact, when the starting position of the defaulting country is a primary fiscal deficit, a marked move into a primary surplus is also required, as the country usually has no longer access to borrowing in the aftermath of a default. This would indeed be the case for many advanced economies today, for which the interest bill is not the main component of the deficit. I agree with Balcerowicz that the standard approach, treating the debt-distressed sovereign as a benevolent social planner maximizing social welfare in an infinite time horizon, is not Cottarelli, Forni, Gottschalk and Mauro (2010). appropriate. Different strategies to cope with a high-debt situation entail different redistributive consequences and social groups have often conflicting economic interests with respect to the policy to pursue in the midst of a debt crisis. The choice made by governments to cope with high public debts may therefore be better explained from a political economy perspective: the specific interests and relative political strength of different constituencies may definitely matter in such a choice. This approach can also help to explain the historically observed phenomenon that some countries are more likely to default than others; 2 to cite just one example, Argentina has defaulted three times since 1980. Moreover, most debt repudiation episodes in these defaultprone countries happened at what we would today consider relatively low levels of debt. At the end of 2001, for instance, when Argentina defaulted on the larger part of its public debt, the debt-to-GDP ratio was slightly above 50 per cent (though already 15 percentage points higher than three years earlier and 90 percentage points below its nominal value one year later, after the 1-to-1 peso-dollar parity had been abandoned). By contrast, there are countries and governments that can sustain much higher borrowing levels. A striking case is Japan, whose public debt recently reached 220 per cent of GDP without giving rise to significant market tensions. Several authors have argued that the degree of debt intolerance ultimately depends on the quality of a country’s institutions. In particular, sovereign default is often the outcome of a political struggle among different groups of citizens and is more likely to happen if domestic debt-holders are politically weak and the political price of the financial turmoil typically triggered by a sovereign bankruptcy is low. These conditions are in turn more likely to be present if a country lacks a politically strong middle class and/or a sufficiently independent central bank 3 . As Balcerowicz remarks, in a world of financial liberalization the traditional distinction between domestic and foreign debt may not be that useful in explaining governments’ willingness to pay. While in the cases of Russia (1998) and Argentina the distribution of the public debt between resident and non-resident holders certainly did matter, with governments treating domestic creditors better than foreign ones, in the case of Turkey (also in 2001) default was not contemplated and the government took measures that helped to service the debt owned by both domestic and foreign creditors. It is worth noting that the share of public debt held by non residents has risen significantly in all European countries, owing to the integration of financial markets. However, not only the composition of debt holders but also other characteristics of the public debt matter in such circumstances. For example, a long enough maturity of government debt can make default avoidable, even for a country that records sizeable increases in yield spreads. The average cost of debt would react slowly, buying the country considerable time to convince the market of its solvency. It can be debated whether the existence of alternative sovereign debt resolution mechanisms can create different ex ante incentives, influencing the behaviour of sovereign debtors and their creditors. The lecture delves into the pros and cons of the Sovereign Debt Restructuring Mechanism (SDRM), a debt resolution mechanism, yet to be implemented, proposed in 2001 by Anne Krueger, then IMF First Deputy Managing Director. Balcerowicz concludes that the SDRM is functionally equivalent to the already existing debt resolution mechanisms, and says that more faith should be placed in the working of “pure market solutions”. However, he also seems to accept the notion that, as the SDRM is a more debtor-friendly mechanism, it could induce more fiscal discipline, strengthening the financial markets early warning function. In my opinion, this is not a secondary aspect. The key to an efficient approach to preventing sovereign distress lies in strengthening market pressure while also making it operate more gradually than is usually the case. An example is the Cf. Reinhart, Rogoff and Savastano (2003). Cf. Giordano and Tommasino (2009). Greek crisis. The spread between 10-year Greek and German bonds was less than 30 basis points in 2007. It widened to about 150 at the end of 2008 in the aftermath of the Lehman Brothers collapse and then fluctuated between 100 and 250 basis points until the beginning of this year. After that it skyrocketed, surpassing 900 basis points in the summer, and only in recent weeks has it fallen back somewhat to below 700. Of course, any institutional reform that forces governments to become more sensitive to the warning signals coming from financial markets is welcome. With the Stability and Growth Pact (SGP) the EU decided to use fiscal rules rather than market constraints, which were considered ineffective and slow in imposing fiscal discipline. As early as 1989, the Delors Committee had remarked that: “The constraints imposed by market forces might either be too slow and weak or too sudden and disruptive” 4 . A solid fiscal framework can improve budgetary coordination over time by removing the built-in bias towards fiscal profligacy that is often attributed to democratically elected governments. A medium-term fiscal framework is particularly important, especially in the current situation, which requires credible plans to anchor expectations and, at the same time, a degree of flexibility in implementation so as not to hamper economic growth. However, it does not follow from this that market forces necessarily have to work only ex post and continue to be “too slow and weak or too sudden and disruptive”. We must strengthen “gradual” market pressure. For that, I believe having pre-defined procedures for debt-restructuring and a well-designed crisis management framework would help greatly. Defaults are certainly “unnecessary, undesirable, and unlikely”, as Cottarelli et al. (2010) assert. But we should not only be ready in case they take place but also have institutions capable of conveying to the market the message that they are in fact possible. The sovereign debt crisis and the institutional setup in the EU I agree with the idea that what we ultimately need is a “strong representation of fiscally conservative voters”. But how can we implement this? In principle, by building a wide consensus on the advantages of fiscal discipline we may actually induce voters to punish policy-makers who do not deliver it. Asking voters to agree on fiscal consolidation packages without convincing them of their advantages is not straightforward. But well-designed, stable and easy to apply fiscal rules can contribute to the emergence of a public consensus in favour of policies aimed at fiscal sustainability. In the second part of his lecture Leszek Balcerowicz focuses on the problem of sovereign debt in the EU, analyzing three main aspects: (i) the management of the Greek crisis; (ii) the development of a debt resolution mechanism in Europe on the heels of the Greek experience; and (iii) longer term solutions for the stability of the euro area. According to Balcerowicz, a double standard emerged between euro- and non-euro countries in the EU. The vulnerable fiscal position of some euro-area countries led to the fear of contagion. After a lengthy debate and with a significant delay, the possibility of an IMF intervention was finally accepted. For non-euro countries, where the risk of contagion was considered modest, the application for IMF conditional loans was not controversial. In the case of euro-area countries, however, such as Greece, a complete set of intervention options was never put on the table; some options were not considered at all, basically due to motives of prestige. With reference to the second point, Balcerowicz charges that the European Financial Stabilisation Mechanism (EFSM) is inconsistent with the letter of the Article 122.2 of the Treaty. He also criticizes the ECB’s Securities Market Programme as a possible threat to its reputation. Finally, turning to the analysis of long-term solutions, he advocates a proper Committee for the Study of Economic and Monetary Union (1989), p. 20. institutional setting able to avoid pro-cyclical policies. Structural reforms should be implemented to spur long-run growth and to promote the adjustment of the economy to shocks. It is quite difficult to assess a single article of the Treaty out of context. The consistency of the EFSM with the letter of the Article 122.2 could be debated, but it is evident that the EFSM complies with the spirit of the Treaty, given the importance of the proper functioning of the EU and its very existence. Earlier this year, it was indeed conceivable that a debt crisis in a euro-area country could trigger a wider crisis involving other countries. Should a balance-of-payments crisis hit a member state, Article 143 of the Treaty governs mutual assistance. Hungary received support on this basis. A similar mechanism was missing in the context of economic and financial crises with impact on sovereign debt. The European Financial Stability Facility (EFSF), established in June by the Ecofin, fills the gap. The crisis has shown that the costs for the economy can mount quickly if crisis management is slow and if it is conditioned by political pressure in both the countries receiving and those providing financial assistance. It is now clearer than before that well-defined procedures need to be established to provide temporary financial assistance under clear and enforceable conditionality. The EFSF is an important step in this direction. In order to guarantee an incentive-compatible scheme, the EFSF has been associated with efforts in strengthening policy coordination in the EU. The crisis has confirmed that the reasons underlying the introduction of EMU fiscal rules (externalities of deficits and debts, pressure for bail out, moral hazard in fiscal policy) are still very relevant, as national rules and financial market discipline do not necessarily deliver sound policies. EU fiscal rules are warranted and should be strengthened. Under the European Commission proposal put forward at the end of September, compliance with rules and principles of the SGP is going to be reinforced by speeding up the Excessive Deficit Procedure and giving more prominence to public debt and sustainability criteria. The broader surveillance of euro-area macroeconomic and competitiveness developments makes it possible to focus on structural issues. The involvement of the EU in developing the ex ante dimension of budgetary and economic surveillance is based on the assumption that prevention can be more effective than correction. Sanctions can play a role in dampening the relative convenience of profligate fiscal policies, but a system of early peer-review of national budgets could detect inconsistencies and emerging imbalances at an early stage. The Van Rompuy task force too will soon publish detailed proposals. It is important that the European Council rapidly evaluate these proposals, jointly with those of the Commission, and come up with an effective decision that tackles the two main weak points of the SGP (in both the 1997 version and the 2005 revision): (i) the absence of incentives and sanctions for fiscal behaviour in good times, and (ii) the lack of an independent enforcer of EU rules. Sanctions have been highly uncertain, as EU Council members were supposed to fine each other via lengthy procedures involving discretionary steps that would lead to theoretically large, but actually unlikely, pecuniary sanctions. Reforms such as the interest bearing deposits and the European semester aim at tackling the first problem. A greater automaticity in procedures, the reduction of EU funds and, possibly, the loss of voting rights would help in tackling the second problem. National fiscal rules and procedures can also help to pursue fiscal consolidation and anchor fiscal expectations. The 2009 reform of the German fiscal framework sets an important benchmark. 5 Other countries may decide to assign a greater role to expenditure rules and to independent fiscal authorities. With respect to the proposals advanced to make the debt criterion operational, the Commission’s suggestion of allowing excessive deficit procedures for insufficient debt reduction (vis-à-vis an annual 1/20 reduction of the excess over the 60 per cent standard for See Franco and Zotteri (2010). the debt-to-GDP ratio over a three-year period) has been praised for its automaticity as well as its simplicity. It has been argued that “the practical translation” of the debt principle is “elegant, but short-termist”, even if this “way of turning around the 60% nonsense is undoubtedly clever”. 6 There is no question, however, that a consistent and progressive reduction of the current high debt levels over the cycle is absolutely necessary; they are a major constraint on our countries’ adjustment possibilities, especially in the event of shocks that could have irreversible consequences (due either to the unwillingness to pay or to the socio-political unfeasibility discussed by Balcerowicz). In this perspective, it seems beside the point at this stage (and impossible given the letter of Treaty) to question the reference standard, as well as the speed of convergence, even if we may readily acknowledge that “business cycles usually extend over more than three years”. 7 The debate on how to cope with the accumulation of public debt following the crisis has led – inter alia – to some proposals for European countries to pool their debt at least up to a certain level (60 per cent of GDP) 8 or to pool in a fund operating in the market (and possibly financed with a levy on financial transactions) the share of their debt directly tied to rescuing the financial system (a proposal not limited, in this case, to the EU). 9 Both types of proposal are interesting and may improve market liquidity. The first would be especially directed at reducing the burden of debt, the second at offsetting the negative consequences of debt accumulation related to the financial crisis. They leave, however, significant open questions. To mention only a couple: (i) it may be hard to reach a consensus on the definition of the share of debt that has to be pooled; (ii) countries having debt substantially in excess of such a share may face a bond market liquidity problem. In addition, these proposals pose problems in terms of incentives to participate for countries with lower debt and higher credibility (typically Germany) and with less debt directly tied to rescuing the financial system (typically Italy). More generally, these schemes imply some cross-subsidization which is hard to price, even though in the case of the establishment of a fund, profits may be used to progressively compensate different country contributions. But we should be aware that weak fiscal positions are not the only source of the tensions on sovereign debt. In 2007 Ireland and Spain recorded fiscal surpluses (respectively 0.3 and 1.9 per cent of GDP) and had relatively low public debt-to-GDP ratios (25 and 36 per cent, respectively). This suggests, as Balcerowicz also acknowledges, that standard fiscal indicators are not sufficient. Moreover, a tighter fiscal policy can sometimes help, but it is not a panacea for macro imbalances. The European Commission now suggests introducing a new Excessive Imbalances Procedure. It will comprise the regular assessment of the risks of imbalances based on a scoreboard composed of several economic indicators. Indicators of both the external position of the economy (e.g. current accounts, external debt, real effective exchange rates) and of the internal situation (e.g. private, as well as public, sector debt) should be considered. The proposal, though important, faces three difficulties: first, detecting macroeconomic imbalances may not be simple; second, identifying appropriate policies to address structural problems is not straightforward; third, putting pressure on a country from Brussels can be politically difficult when all seems to be going well. This is an area in which national independent authorities could have a role. A very important issue concerns the lessons we have learnt from the crisis for the design and the conduct of our monetary policy, as well as for its interactions with macro-prudential policies. If anything, the crisis has confirmed that we should firmly stick to our objective to Wyplosz (2010). Ibidem. Cf. Delpla and Von Weizsacker (2010). V. Visco (2010), and, for a similar proposal that contemplates the transfer of such debt in excess to an international institution such as the IMF, Savona (2010). deliver price stability in the medium term. Indeed, the credibility of the Eurosystem in pursuing this objective was crucial in allowing us to adopt exceptional measures without compromising the anchoring of inflation expectations. The crisis has also shown how important it is to interpret credit and money developments properly and take them into account in our decisions, in particular by “leaning against the wind” in case of credit booms and asset price imbalances. This is embodied in the Eurosystem setup, insofar as the careful monitoring of monetary and credit aggregates helps to identify risks both to financial and price stability. A crucial issue is how to detect the accumulation of systemic risk in time. I am confident that the new framework based on the ESRB will provide a fundamental contribution in this respect. Enhanced interaction among macro-prudential bodies, between them and the micro-prudential authorities, and between macro-prudential and monetary policy authorities will be crucial. With reference to the ECB’s Securities Market Programme, suffice it to say that developments in financial markets called for special interventions. The programme is in line with the shared principles of European monetary policy-making and does not represent a change in the monetary policy stance. The current financial crisis has been described as valuation crisis. In fact, bond spreads for several euro-area countries widened beyond any reasonable level, and severe tensions in the bond market hampered the monetary policy transmission mechanism, demanding action by the central bank. However, a very important and more immediate issue is the exit from the exceptional monetary policy measures that have been adopted. All the various non-conventional measures that central banks, including the ECB, have taken over the last years have been directed at avoiding a financial and economic collapse. That collapse has not materialized. The relevant issue now is the timing and speed of the exit from these measures. This will have to be guided, on the one hand, by the need to maintain support for the orderly functioning of the money and financial markets and to sustain credit flows to the economy, and, on the other hand, by the need to avoid introducing distortions into the system and sowing the seeds of future imbalances. In the euro area, our “credit enhancing” policy was almost entirely based on temporary refinancing to the banking system and can easily be unwound. Indeed, gradual phasing out has started with the maturity of the six-month and twelve-month operations. The speed with which the exit will proceed will depend on how quickly financial markets get back to normality, on the pace of the economic recovery, on banks’ ability to obtain stable funding from private capital markets. Finally, as Balcerowicz forcefully argues, an adequate response to debt distress requires to counter with decision the ongoing erosion of fiscal discipline. Structural reforms that are perceived as capable of enhancing a country’s adjustment possibilities, such as those that would lead to the removal of unnecessary administrative barriers, a higher efficiency of public services and a substantial improvement of the education system, are also of fundamental importance. Furthermore, in the market perception what matters most for debt sustainability is the ability to implement specific initiatives, capable of affecting the medium- to long-term growth possibilities of a country as well as the trends in its public expenditures, rather than the (ephemeral) short-term flexibility of its (nominal) exchange rate. This is what is shown, inter alia, by the Italian experience of 1992–95, when the adoption of a critical pension reform was what really mattered to convince markets of the return to a sustainable trend in public finances. References Committee for the Study of Economic and Monetary Union (1989), Report on the economic and monetary union in the European Community, Brussels. Cottarelli, C., L. Forni, J. Gottschalk and P. Mauro (2010), “Default in today’s advanced economies: Unnecessary, undesirable, and unlikely”, IMF Staff Position Note, 10/12, September. Delpla, J. and J. Von Weizsacker (2010), “The blue bond proposal”, Bruegel Policy Brief, 2010/3, May. Franco D. and S. Zotteri (2010), “Fiscal rules: What lessons from Germany?”, mimeo, Banca d’Italia. Giordano, R. and P. Tommasino (2009), “What determines debt intolerance: the role of political and monetary institutions”, Temi di discussione, 700, Banca d’Italia, January. Reinhart, C., M.K. Rogoff and M.S. Savastano (2003), “Debt intolerance”, Brookings Papers on Economic Activity, 1. Savona, P. (2010), “Un parcheggio per i debiti pubblici del mondo”, Il Messaggero, 18 febbraio. Visco, V. (2010), “Come salvarsi dalla deflazione”, Il Corriere della Sera, 13 luglio. Wyplosz, C. (2010), “Eurozone reform: Not yet fiscal discipline but a good start”, Vox, 4 October. | bank of italy | 2,010 | 12 |
Speech by Mr Ignazio Visco, Deputy Director General of the Bank of Italy, at the Conference in memory of Tommaso Padoa-Schioppa, European University Institute, Badia Fiesolana, 28 January 2011. | Ignazio Visco: Tommaso Padoa-Schioppa, “Architect …” Personal remarks by Mr Ignazio Visco, Deputy Director General of the Bank of Italy, at the Ceremony in memory of Tommaso Padoa-Schioppa, European University Institute, Badia Fiesolana, 28 January 2011. * * * A prominent (but non-academic) economist, a leading central banker (in Italy and in Europe), a “non-political” politician (dedicated to the “polity” rather than to the politique politicienne), Tommaso Padoa-Schioppa spanned all of these professions in the course of his eminent career. Tommaso’s achievements were substantial, as everyone recognizes. He is rightly considered as one of the “architects of the euro.” A man of vision, an independent mind, an indefatigable civil servant – we have been fortunate indeed to have had Tommaso PadoaSchioppa as colleague, friend, mentor. Mine will not be a eulogy or a historical account of Tommaso’s many achievements. Division of labour and the time constraint have counselled concentrating on his contributions as an officer of the Bank of Italy. Perhaps the term “officer” is a bit limited, although I am sure that he would have appreciated it. He was the head of the Money Market Division of the Bank’s Research Department from 1975 to 1979, when he left to become Director General for Economic and Financial Affairs at the European Commission. He returned to the Bank in 1983, was named Deputy Director General in 1984 and served in that capacity for thirteen years. He certainly left his mark. Developments in at least three areas would most likely have been substantially different, and with a cost-benefit balance substantially in the red, had his influence not been exercised so effectively. The three areas comprise the “reshaping of monetary policy”, as he came to define it, 1 the promotion and implementation of a groundbreaking reform of the payment system 2 and the process of European monetary unification. 3 These recollections of mine are certainly not exhaustive, and if in places they are marred by some inevitable inaccuracies, let me apologize in advance. More than two decades of observation of Tommaso’s accomplishments at the Bank, with at times lengthy discussions, followed by a decade and a half of exchanges after his departure to become successively Chairman of Consob, Member of the Board of the ECB, and Italy’s Minister of Economy and Finance cannot be summarized in a few minutes. And memory is sometimes incomplete and distorted, even if I have had the benefit of some brief conversation with some of his closest collaborators during those years. 4 In any case, I am sure that my recollection of his accomplishments errs on the side of understatement. Let us remember that in the 1970s the Italian economy was plagued by substantial nominal and real instability. High and volatile inflation rates preceded, accompanied, and followed a series of large and sometimes sudden depreciations of the currency, in a context of social unrest and substantial rigidities. For several years the economy we lived in was the “100% I will only provide very limited references to his extensive written contributions, but on the reshaping of monetary policy we are fortunate to have his views and assessment summarized in the contribution to Franco Modigliani’s Festschrift (Macroeconomics and Finance, Essays in Honor of Franco Modigliani, edited by Rudiger Dornbusch, Stanley Fischer and John Bossons, MIT Press, Cambridge, Mass., 1987, pp. 265–86). A collection of Padoa-Schioppa’s speeches and papers on the payment system has been published, in Italian, in the book La moneta e il sistema dei pagamenti, Il Mulino, Bologna, 1992. It is sufficient here to refer to the writings contained in his book on The Road to Monetary Union in Europe, Clarendon Press, Oxford, 1994. I would especially like to thank Giovanni Carosio, Francesco Papadia and Franco Passacantando for sharing some of their memories with me in the process of writing down these recollections. BIS central bankers’ speeches plus” indexed economy described in well-known essays written together with Franco Modigliani in 1977–78. 5 Meanwhile, Italian society was racked by violent waves of terrorism. The policy challenge was enormous, as Italy’s financial markets were very underdeveloped, public debt management non-existent, and capital flights massive. The large and rising budget deficits were being financed only by the central bank and the banking system. Financial repression was extensive, with such administrative measures as controls on capital movements, interest rate caps, ceilings on bank credit to the private sector, and constraints on banks’ portfolio investment. Administrative controls became a generalized system of monetary and credit management. It required monitoring and supervision, as well as the capacity to balance the inconsistencies and conflicts that necessarily flowed from the lack of market infrastructures, the co-existence of qualitative and quantitative credit controls, and the central bank’s inability to affect the interest rate. Tommaso experienced this in his daily activity, which included constant advising to the Bank’s governors as well as to the government. And in that same period, the Bank of Italy was laying the foundations of a “new system” that would shift over to indirect monetary controls and open market operations. The compulsory reserve regime was radically revised, the method for issuing Treasury bills was reformed to admit the Bank’s participation at auctions and enhance its ability to affect the interest rate. In 1981, while Tommaso was serving with the European Commission, an epoch-making regime shift took place, to which he had contributed directly and indirectly: the so-called “divorce” between the Bank of Italy and the Treasury. The Bank ceased to act as residual buyer at Treasury bill auctions, the fundamental first step towards full independence for the Bank’s monetary policy decisions. This was followed in the 1980s by a thorough transformation of the financial infrastructure: direct controls were suppressed, reserve requirements reformed, competitive-bid auctions for Treasury bills introduced, longer-term Treasury bonds (with the introduction of uniform price auctions) and indexed Treasury credit certificates were instituted, a screen-based secondary market was established for government securities (the MTS, with the introduction in 1994 of market specialists) as well as a screen-based market for inter-bank deposits (later to become the e-MID), futures and options on Treasury bonds were launched on LIFFE, and more. Tommaso Padoa-Schioppa contributed much of his time, energy, and vision to these radical changes. Many other changes took place over those same years. The European Monetary System (EMS) was established, in the second half of the 1980s exchange controls were removed and capital movements were completely liberalized (by 1990), the Bank of Italy was granted not only de facto but also de jure independence, the wage indexation system was substantially revised and eventually put to rest, and a major currency and financial crisis struck the Italian economy as budget deficits and the public debt seemed to be out of control. Eventually, of course, the crisis was overcome, inflation was tamed, the public finances were brought under control. This is clearly another story, one that took a benign turn thanks also to the many infrastructural changes that had made it possible for monetary policy to play its proper role within a transparent and well-organised financial architecture. It is natural, today, to take it for granted that a transparent and well-organised financial architecture necessarily includes a smooth, well-functioning and economical payment system for clearing and settlement. But this is a relatively recent achievement, one that has benefited greatly from the information and communication technology revolution. In the mid-1980s the payment system, and not only in Italy, was rather neglected and far from well-organised. Tommaso was convinced that central banks’ tasks should comprise not only money creation Franco Modigliani and Tommaso Padoa-Schioppa, “La politica economica in una economia con salari indicizzati al 100% o più”, in Moneta e Credito, No. 117, March 1977, and “The Management of an Open Economy with ‘100% Plus’ Wage Indexation”, in Essays in International Finance, Princeton University, No. 130, December 1979. BIS central bankers’ speeches and inflation targeting but also improving the mechanisms of monetary circulation, instituting reliable and efficient infrastructures, and what is now called “transaction banking”. In a market economy the costs of a dysfunctional payment system could be just as great as those deriving from volatile inflation rates. This was particularly evident in Italy, where at the time the settlement of cheques or the completion of a credit transfer were long and cumbersome processes that involved a fragmented set of bilateral arrangements among banks. The reforms that Tommaso Padoa-Schioppa promoted at the end of that decade successfully bridged the gap between Italy’s system and that in place in the other major economies. In a first phase, from 1989 to 1993, the reform involved the system for netting in central bank money, with the launch of dedicated projects for various payment types (customer paper-based and electronic, inter-bank, foreign exchange, securities trading). He then promoted a national, centralised real-time gross settlement system in central bank money that exploited the most advanced technologies and that would quickly make central banks the leaders in this sphere. Eventually, the system was adapted to be fully integrated into the network of euro-area payment systems (the TARGET structure). In parallel with these architectural and technological developments, Tommaso forged an intellectual environment that produced important economic research in the field of payment systems that now enjoys worldwide recognition. At the time he was deeply involved in the process of European monetary unification and soon realized that the creation of a single currency would have to be accompanied by the institution of a unified mechanism for its circulation throughout the European economy. A workshop that he organized at the Bank’s conference centre in Perugia (SADiBa) in November 1991 revealed how fragmented the procedures and mechanisms of the various European countries were and paved the way for the payment system agenda of the years following. From 1991 to 1995 Tommaso chaired the Working Group on Payment Systems of the central banks of the European Community; he resumed this project when he joined the Governing Council of the European Central Bank. In that position he promoted a revolutionary arrangement by which each country would delegate the large-value settlement of inter-bank transactions to a centralised system run by three central banks on behalf of the entire Eurosystem. This is how TARGET was revolutionized, transformed into a highly efficient, secure single shared platform for the benefit of the European financial system (TARGET2, created and jointly managed by the Bank of Italy, the Deutsche Bundesbank and the Banque de France). His worldwide leadership in the area of payment systems received an important recognition when he was nominated Chairman of the Basel Committee on Payment and Settlement Systems, a position that he held from 2000 to 2005. Europe’s resolve to fight inflation and enhance monetary stability was at the basis of the establishment of the EMS in 1979. With the Single European Act of 1985, it was decided to form the “single market” and to fully liberalize capital movements and foreign exchange transactions. The European Council meeting in Hannover in 1988 created the Delors Committee; through a surprisingly smooth and rapid process – even if at the time it seemed time-consuming and rather complex – this led to the Treaty of Maastricht and, eventually, the EMU. We all know the crucial role, intellectual as well as practical, that Tommaso PadoaSchioppa played in this process, as joint secretary, with Gunter Baer, to the Delors Committee. I needn’t add much to this, save to recall a couple of issues. I am sure that if we ask even well informed people what the initials “EMU” stand for, we will hear, most of the time, “European Monetary Union” as an answer. Actually, of course, it is “Economic and Monetary Union”. From 1979 to 1983 Tommaso was, as I recalled, Director General for Economic and Financial Affairs at the European Commission. In that capacity he oversaw the initial operation of the EMS and was certainly instrumental in paving the way to BIS central bankers’ speeches the actions that would lead to the Single European Act. 6 But he was persuaded, from the analytical perhaps even more than from the political standpoint, that “the EMS is not enough”, and that the full implementation of the programme set out in the Single European Act would give rise to an “inconsistent quartet” in an area characterized by free trade, full capital mobility, fixed (or managed) exchange rates and national monetary policies. (This thesis, without explicitly setting the condition of free trade, had already been set forth in the literature, as a dilemma or an impossible trinity, by Robert Triffin and others). 7 I said “from the analytical standpoint”, but I might have also said “architectural”. I believe that Tommaso’s ambition, and the founding role that he played in this process, from the initial ideas to the (indirect) negotiation of the details of the Treaty articles and the actual establishment of the Union, was exactly to create a proper institutional set-up for an idea of Europe designed to improve the well-being of its citizens and ensure fruitful interaction with the rest of the world. At times, there is criticism of what can be seen as a “technocratic” approach to political union. But Tommaso was well aware of what he called the ambiguity, in the development of Europe, “between a purely economic project and a political project, between confederation and federation, between a free-trade area and a single market, between technocracy and democracy, between Jean Monnet’s functionalism and Altiero Spinelli’s constitutionalism”. 8 He understood very well the risk of a “democratic deficit” and the limitations of “a currency without a State”. 9 So Tommaso Padoa-Schioppa has been widely identified as a (if not the) “founding father of the new currency,” “architect of the euro”. I believe that this is proper, but I wanted to emphasise that Tommaso was also deeply convinced of a notion clearly expressed by James Tobin, namely that as “Policy and structure become inextricably combined, their joint product is what matters. … One way to alter the operating properties of the system … is to change the policy rule. Another way is to change the structure”. 10 And it was to changing structures that he devoted much of his intellectual and professional life. For several years, while still at the Bank of Italy, he was Chairman of the Basel Committee, where he initiated a process that would lead to what came to be called the “Basel II” Accord. The regulatory system was built around the basic notion that banks should set aside capital to guard against the various types of risk: credit, market, operational. The financial crisis has taught us that both the assessment of and the allowance for these risks were vastly inadequate. Tommaso recognized this. Still, he maintained that Basel II was definitely better than the previous accord precisely because it sought to specify in detail the various risks in banking and to provide, through its “three pillars” construction, a comprehensive framework to deal with them. He conceded that substantial changes at the technical level of the Accord were necessary, but he emphasized, in his Per Jacobsson lecture last June, that “what really went wrong is on the side of the government [which] was captured by the myth that finance can regulate itself spontaneously and hence retreated too much from the regulatory and See, on this, his book co-authored with Michael Emerson, Mervin King, Jean-Claude Milleron, Jean Paelink, Lucas Papademos, Alfredo Pastor and Fritz Scharf, Efficiency, Stability and Equity. A Strategy for the Evolution of the Economic System of the European Community, Oxford University Press, London, 1987 See, “The EMS is not Enough: The Need for Monetary Union”, 1987 (chapter 6 of The Road to Monetary Union, cit.), and “Squaring the Circle, or the Conundrum of International Monetary Reform”, in Catalyst, a Journal of Policy Debate, Spring 1985. The Road to Monetary Union, cit., p. 22. See, finally, The Euro and its Central Bank. Getting United after the Union, MIT Press, Cambridge, Mass., 2004. James Tobin, “Financial Structure and Monetary Rules, in Kredit und Kapital, 2, 1983, quoted in “Reshaping Monetary Policy”, cit. p. 283. BIS central bankers’ speeches supervisory role that is necessary to ensure stability.” 11 The financial market, that is, is a fundamental mechanism of our economies; but it is not an abstract concept. In the real world it appears as a complex infrastructure developed through a laborious process, with a set of well-specified rules of the game and the need for an attentive and vigilant supervisory system. In the same lecture Tommaso returned to another recurrent theme of his, the need to move beyond the level of the “nation state” – in this case in order not to leave “the rapid emerging reality of global finance” unmanaged. And to the improvement of international cooperation and the reform of the international monetary system he devoted his last days, through the group that he convened with Michael Camdessus and Alexandre Lamfalussy – what is now called the “Palais-Royal Initiative”. 12 To conclude, Tommaso Padoa-Schioppa was a true leader, a man with whom it was always instructive to engage in a conversation, but at your own risk – always with the assignment, that is, be it explicit or implicit, of producing a concrete, real-world result. His professional life may well be compared to the work of a creative and passionate architect. He was not, and he did not pretend to be, “always right”. But, like the builders of the medieval cathedrals that enrich Europe, he was a “man of vision,” a believer but also a very practical man. He was loyal to the institutions which he served but no slavish follower of received tradition. He contributed substantially, through his example, his writings, his actions, to the advancement of our society. He worked tirelessly and effectively for a better country, a better Europe, a better world than the one into which he was born. “Markets and government before, during and after the 2007–20xx crisis”, Per Jacobsson lecture, Basel, 27 June 2010. Palais-Royal Initiative, “Reforming the International Monetary System. A Cooperative Approach for the Twenty First Century”, Paris, January 18, 2011. BIS central bankers’ speeches | bank of italy | 2,011 | 1 |
Speech by Mr Ignazio Visco, Deputy Director General of the Bank of Italy, at the Bank of Korea-Bank for International Settlements (BOK-BIS) Conference on Macroprudential Regulation and Policy, Seoul, 18 January 2011. | Ignazio Visco: Key issues for the success of macroprudential policies Speech by Mr Ignazio Visco, Deputy Director General of the Bank of Italy, at the Bank of Korea–Bank for International Settlements (BOK-BIS) Conference on Macroprudential Regulation and Policy, Seoul, 18 January 2011. * * * I would like to thank Paolo Angelini and Sergio Nicoletti Altimari for highly useful discussions and assistance. 1. Macroprudential objectives and tools While the objectives of monetary and fiscal policies are clearly defined, and often precisely quantified, the situation is less clear in the case of financial stability. A broad consensus has emerged on the idea that “macroprudential” policies directed to preserving financial stability should limit systemic risk by addressing both the cross-sectional dimension of the financial system, with the aim of strengthening its resilience to adverse real or financial shocks, and its temporal dimension, to contain the accumulation of risk over the business or financial cycle. The first dimension seems to me to be of paramount importance. The second dimension emphasizes the need to contain the pro-cyclicality of the financial system, i.e. to “lean against the financial cycle”. 1 Other authors argue that policy should be assigned more specific objectives, such as combating fire sales and credit crunches. 2 A key problem is that, whether a broad or a specific mandate is chosen, we are still far from an operational definition of these objectives. We do have an ample array of indicators and early warning signals, but we still lack a coherent framework to interpret them, to assess the need for macroprudential intervention, and to measure the success of the policies adopted. While the notion implicit in all definitions of macroprudential objectives is that what warrants a macroprudential regulatory intervention is systemic risk (a negative externality), systemic risk presents a number of challenges to the policymaker. First, it is hard to measure, because of its various dimensions: pro-cyclicality; network or contagion risk – the spillover effects of a single institution’s distress on the rest of the financial system; correlation risk, which reflects the common exposures of all financial institutions to the same risk factors; concentration risk, due to the presence of a few dominant institutions in key financial markets and activities. Second, systemic risk may be extremely difficult to spot ex ante. For instance, in the late 1990s the hedge fund industry was considered a main source of systemic risk, and a candidate for regulation, but this risk did not materialize. By contrast, the recent crisis provides several examples of triggers that did have systemic consequences but were not seen as crucial ex ante: the behaviour of certain insurance companies; the supposedly safe mortgage market of the world’s financially most developed system; the European sovereign debt market. 3 These difficulties in measuring systemic risk have important implications for the practical implementation of macroprudential policy and for the accountability of the macroprudential authority. As the new authorities start working, they will have to base their decision-making on operational arrangements. The year that has just begun will be very important in this respect. See, for example, Bank of England (2009) and Borio (2003), (2010). See Hanson, Kashyap and Stein (2010). See Carosio (2010). BIS central bankers’ speeches Similar difficulties emerge in the definition of the appropriate macroprudential tools. Financial crises are often associated with wide fluctuations in credit and asset prices. Recent analyses indicate that such tools as countercyclical capital requirements or loan-to-value ratios can attenuate the volatility of credit and asset prices and dampen the pro-cyclicality of the financial system, helping to reduce the likelihood of financial crises. 4 At the same time, because systemic financial risk can emerge from many sources, different instruments may be required, to be chosen case by case. Furthermore, instruments may be under the control of different authorities, for example those responsible for microprudential, fiscal or other economic policies. This might significantly add to the complexity of the policy process, reducing its timeliness and hence the likelihood of success. In Europe, responsibility for macroprudential policies has been assigned to a new body, the European Systemic Risk Board (ESRB), within the context of a comprehensive reform of the European supervisory architecture approved by the European political authorities in the autumn of 2009 following an in-depth analysis conducted by the De Larosière Committee and the European Commission. The reform also introduces a European System of Financial Supervision (ESFS) comprising, besides the macro-prudential authority, three new European Supervisory Authorities (ESAs) for the banking, securities and insurance sectors. The new authorities started operating on 1 January 2011. Regulation No. 1092/2010 of the European Parliament and of the Council assigns a broad mandate to the ESRB, charging it with macroprudential oversight of the financial system within the European Union in order to contribute to the prevention or mitigation of systemic risks to financial stability in the Union. 5 To this end the ESRB is to conduct analyses of the European financial system, issue risk warnings and, when called on, make recommendations, which it will submit to one or more member states or national supervisory authorities, the EU Council, the European Commission and the newly established ESAs. It will decide, after consulting with the Council, whether to make its recommendations public and will monitor follow-up, informing the Council and the ESAs where it finds the action taken to be inadequate. The ESRB itself does not have direct enforcement power; it will act mainly through other (European or national) authorities, essentially via an “act or explain” mechanism. Its lack of direct enforcement powers is a key difference with respect to the arrangement in the United States, where the new macroprudential body, the Financial Stability Oversight Council (FSOC), is assigned direct intervention tools, including at the micro level. As the new authorities begin working, it will be important to monitor how this difference influences the policy outcomes. A key challenge for the ESRB is to ensure that its recommendations have teeth, that the “act or explain” mechanism produces a good balance between the “act” and the “explain”. A second important challenge for the ESRB will be to ensure that countryspecific and/or sectoral warnings or recommendations, when required, are adopted in a timely fashion. The European experience of the last three years suggests that recommendations of this type would probably have been more effective than general recommendations to counter developments that turned out to have implications for European financial stability. The complexity of the ESRB’s structure might make it difficult to reach a consensus on national recommendations. A third challenge for the ESRB will be to ensure See Angelini, Neri and Panetta (2010) and Lambertini, Mendicino and Punzi (2011). Article 3(1) of the Regulation: “The ESRB shall be responsible for the macro-prudential oversight of the financial system within the Union in order to contribute to the prevention or mitigation of systemic risks to financial stability in the Union that arise from developments within the financial system and taking into account macroeconomic developments, so as to avoid periods of widespread financial distress. It shall contribute to the smooth functioning of the internal market and thereby ensure a sustainable contribution of the financial sector to economic growth.” BIS central bankers’ speeches effective cooperation with the authorities of the new European System of Financial Supervision. 2. Interaction between macroprudential and monetary policies The objectives of macroprudential policies should be kept separate from those of more traditional policies. There is consensus that there is no need to change central banks’ current mandate of preserving price stability over the medium term. The benefits of a sound monetary framework have become more – not less – evident during the crisis. Had central banks failed to control inflation, and inflation expectations, monetary policy would have had much less room for manoeuvre. However, the increasing emphasis on financial stability and macroprudential policies poses challenges to monetary policy. Central banks should not have to stand by idly until a crash occurs before intervening. There is evidence that a loose monetary policy can stimulate excess risk-taking and leverage, or liquidity transformation, thus increasing systemic fragility and ultimately putting price stability itself at risk. 6 Just how this should affect the conduct of monetary policy is still unclear. At the very least, however, we have learned that monetary policymakers should be aware of these channels and monitor a broad range of indicators, such as buoyant credit growth, increasing leverage of financial institutions and, in general, leading indicators of financial instability. Some authors argue that monetary policy should react to financial variables and more generally to leading indicators of financial distress. 7 Over longer horizons there is no evident trade-off between price stability and financial stability objectives – indeed, there are probably synergies. We need to lengthen the horizon of monetary policy by taking into account the interactions and feedbacks between the real and the financial sectors and the non-linearities that emerge especially during crises. Many of the effects associated with financial and asset prices imbalances are likely to be highly non-linear and complex. The reaction of monetary policy should then also be non-linear and respond to asset price misalignments and financial imbalances. When the probability of a crisis becomes non-trivial, the interest rate path towards ensuring price stability might be different than in normal circumstances. These aspects are not well captured in the empirical models currently used to support monetary policy decisions, and, I would argue, in the prevailing flexible inflation targeting framework. 8 There is a great need for further research to overcome these limitations. Monetary policy and financial stability policy interact and influence one another. Monetary policy affects asset prices and credit, whose developments are crucial for financial stability, Borio and Zhu (2008) argue that such a channel exists. Altunbas, Gambacorta and Marques-Ibanez (2010), Maddaloni and Peydró (2010) find empirical evidence consistent with this channel. See Woodford (2010), Cúrdia and Woodford (2010), and Lambertini, Mendicino and Punzi (2011), among others. On the contrary, it is generally accepted that a flexible inflation targeting (FIT) approach, if sufficiently forward looking, should (perhaps informally) take account of the fact that “significant financial instability invariably will also have a significant impact on activity and inflation” (Bean, 2003, p. 18). In practice, however, in the design of monetary policy actions it might be very difficult to take account of developments that are subject to considerable uncertainty and may materialize with long lags due to cumulative and non-linear effects of financial imbalances. Since “the real world is generally complex and non-linear, [even] within a well specified FIT framework, the implicit monetary policy reaction function would then also be non-linear (and possibly very complex, as it would not be possible to rely on certainty equivalence)” (Visco, 2003, p. 24), Indeed, considering a Taylor rule as a description of the normal conduct of monetary policy, I argued that for some purposes a linear rule with the interest rate expressed as a function also of asset price misalignments could be a simple and linear approximation (a Taylor “approximation”, after Brook Taylor the mathematician, within the Taylor “rule” introduced by John Taylor the economist!) of how central banks would behave (or perhaps should have behaved) in a non-linear and complex environment. BIS central bankers’ speeches and the propensity to take risks. At the same time, macroprudential policies will likely react to, and affect, credit growth and asset prices, influencing the monetary policy transmission mechanism. These interactions need to be well understood and taken into account in formulating the two policies. Two research projects recently carried out at the Bank of Italy have focused on the interaction between monetary policy and macroprudential policy. The first study concentrates on the recent housing bubble in the United States. 9 The results indicate that a tighter monetary policy by the Fed between 2002 and 2006 would have not been sufficient to avoid the bubble. However, by appropriately combining a tighter monetary policy with additional credit restraint by means of an aggressive use of countercyclical macroprudential tools, policymakers could have dampened the housing boom. The second study suggests the need for coordination between monetary policy and countercyclical macroprudential policy, to avoid conflicts in the use of their respective instruments (e.g., interest rates and bank capital ratios). 10 While the benefits of such coordination are small in “normal” times, they can become substantial when the economy is hit by financial shocks that severely impair the ability of the banking sector to provide credit to the economy. In this case, it may be optimal for the central bank to “lend a hand” to macroprudential policy, partly deviating from its primary objective of price stability in order to improve the overall stability of the economy. To what extent do countercyclical macroprudential policy and monetary policy have the potential to affect the economy independently of each other? Answering this question requires the development of new analytical frameworks. The ideal framework should be simple enough to allow a proper understanding of the basic underlying mechanisms; at the same time, it should be sufficiently realistic to permit the two policies to usefully coexist, at least in principle. Clearly, this would be impossible in a very simple framework. For instance, in a standard AS-AD New Keynesian model, the two policies would be perfectly linearly dependent, as they both end up influencing the only control available to the policymaker, the interest rate, either through open market operations or via the macroprudential instrument. In one possible modelling of the two channels, suggested by Angelini, Neri and Panetta in the above-mentioned Bank of Italy paper, monetary policy would set the level of the nominal interest rate, as in standard models, while countercyclical macroprudential policy would influence the differential between the interest rate on bank loans and the rate on deposits by setting a capital ratio. Is this channel powerful enough to make a difference? Are there other possible channels? In my view, these issues will require a substantial research effort. In Europe, consistency between monetary and macroprudential policies should be ensured by the structure of the ESRB, characterized by its close relationship with the European System of Central Banks, which represents the backbone of the new institution. 11 In practice, 29 of the 37 voting members are central bankers, so central bankers alone can ensure the Catte, Cova, Pagano and Visco (2010). Angelini, Neri and Panetta (2010). The ESRB General Board is composed of the president and the vice president of the ECB, the governors of the 27 central banks of the European Union, a representative of the European Commission, the chairs of the three ESAs, the chair of the Advisory Technical Committee (an advisory body made up of the representatives of all institutions participating in the ESRB) and three external members (the chair and the two vice-chairs of the Advisory Scientific Committee, a new advisory body made up of experts), all with voting rights. In addition, the representatives of the national supervisory authorities and the chair of the EU Economic and Financial Committee (EFC) will participate to the meetings without the right to vote. The chair of the ESRB is assigned to the president of the ECB for the first five years (for subsequent mandates possible amendments to this provision will be assessed by the European Parliament and the Council by December 2013). A Steering Committee is in charge of preparing meetings and ensuring efficient ESRB operations. The Steering Committee consists of the ESRB chair and vice-chair, five central bank members of the ESRB, the chairs of the ESAs, the chair of the EFC and the Commission member. BIS central bankers’ speeches simple majority required for General Board approval, as well as the qualified majority of two thirds required to adopt a recommendation or to make a warning or recommendation public. The scope for potential conflicts between policies should also be limited to the extent that the tools and actions of macroprudential policies are normally more selective, sectoral and geographically defined. For example, dealing with house price booms in a region or country in the currency union will be an issue for macroprudential policy; a generalized credit boom, on the other hand, will likely be a matter of concern for monetary policy as well. 3. Interaction between macroprudential and microprudential policymakers A number of practical examples show that microprudential tools (capital and liquidity requirements, loan-to-value ratios, etc.) may be appropriately calibrated to serve macroprudential goals as well. If the tools are broadly the same but must serve two purposes and be used by two different authorities, the potential for conflict arises. It is not hard to imagine a scenario of economic downturn in which the macroprudential regulator would want to run down the equity buffers built up during good times in order to avoid a credit crunch, while the microprudential regulator, concerned with preserving the safety and soundness of individual institutions, might be reluctant to let that happen. Overall, there are both strong complementarities between macro and microprudential policies – it is hard to imagine the success of one policy without the success of the other – and potential short-term conflicts and overlaps. Whatever the institutional arrangements, it is crucial to ensure a continuous exchange of information and to set up well-defined mechanisms to resolve any conflicts between the two functions. From this viewpoint, the US system appears well-designed. In Europe, the interaction between macroprudential and microprudential authorities may be relatively complicated: the latter include the Basel Committee, the European Banking Authority, the other European supervisory authorities and the national supervisors. Cross-participation in the governing bodies of the different authorities should limit coordination problems, but it is clear that the European regulators will be called upon to make efforts in this direction. Indeed, a proposal for a Memorandum of Understanding among the ESRB and the ESAs on the division of responsibilities between micro and macrosupervisors is now being discussed. Access to micro data may be problematic for the ESRB. Successful analysis will probably require the ESRB and its Secretariat to act as a hub, devising meaningful projects, decentralizing much of the analytical work to national authorities, and ensuring harmonization of the research protocols. 4. Coordination among macroprudential bodies The new macroprudential regulatory framework will feature a primary role at the global level for four “global” players – the IMF, the Financial Stability Board (FSB), the ESRB and the FSOC – and for a number of national macroprudential authorities. Effective action will require a stepped-up interaction and cooperation among these authorities. The IMF and the FSB are developing a monitoring process (the so-called Early Warning Exercise) that permits a more integrated and comprehensive view of emerging global developments and the corresponding risks. Using an integrated macro-financial and regulatory perspective, the process should provide a first example of an organized, structural attempt to identify and prioritize systemic macro-financial risks at global level and to propose policy responses. The ESRB will also conduct a regular assessment of systemic risk and, when necessary, translate it into recommendations for the adoption of mitigating policies. The potential for overlap seems ample. Given the global mandates of the FSB and the IMF, effective collaboration could have these two organisations focussing on the analysis of linkages and contagion channels across the main macro areas and on developing policy BIS central bankers’ speeches options to contain spillover risk. The ESRB, the FSOC and analogous national and regional institutions elsewhere could focus on sources of risk arising within their jurisdictions and devise policy measures to address domestic developments. The coming years will be crucial to assess the functioning of the new framework and to minimize potential inefficiencies. References Altunbas, Y., L. Gambacorta and D. Marqués-Ibáñez (2010), “Does monetary policy affect bank risk-taking?”, ECB Working Paper, No. 1166. Angelini, P., S. Neri and F. Panetta (2010), “Monetary and macroprudential policies”, mimeo, Banca d’Italia. Bank of England (2009), “The role of macroprudential policy: A discussion paper”, November. Bean, C. (2003), “Asset prices, financial imbalances and monetary policy: are inflation targets enough?”, BIS Working Papers, No. 140. Borio, C. (2003), “Towards a macroprudential framework for financial supervision and regulation?”, BIS Working Papers, No. 128. Borio, C. (2010), “Implementing a macroprudential framework: Blending boldness and realism”, keynote address for the BIS-HKMA research conference on “Financial Stability: Towards a Macroprudential Approach”, Honk Kong SAR, 5–6 July 2010 (available at http://www.bis.org/repofficepubl/ hkimr201007.12c.pdf). Borio, C., and H. Zhu (2008), “Capital regulation, risk-taking and monetary policy: a missing link in the transmission mechanism?”, BIS Working Papers, No. 268. Carosio, G. (2010), “Central Banking after the Crisis: Responsibilities, Strategies, Instruments” paper presented at the OeNB – 38th Economic Conference, June 1. Catte, P., P. Cova, P. Pagano and I. Visco (2010),”The role of macroeconomic policies in the global crisis”, Banca d’Italia, Occasional Papers, No. 69. Cúrdia, V., and M. Woodford (2010), “Credit Spreads and Monetary Policy,” Journal of Money, Credit and Banking, 42(6 Supp.). Hanson, S., A. Kashyap and J. Stein (2010), “A macroprudential approach to financial regulation”, Journal of Economic Perspectives, forthcoming. Lambertini, L., C. Mendicino and M.T. Punzi (2011), “Leaning against boom-bust cycles in credit and housing prices”, this conference. Maddaloni, A., and J-L. Peydró (2010), “Bank Risk-Taking, Securitization, Supervision and Low Interest Rates. Evidence from the Euro Area and the U.S. Lending Standards”, ECB Working Paper, No. 1248. Visco, I. (2003), “Discussion of “Asset prices, financial imbalances and monetary policy: are inflation targets enough?” by Charles Bean”, BIS Working Papers, No. 140. Woodford, M. (2010), “Financial Intermediation and Macroeconomic Analysis”, Journal of Economic Perspectives, forthcoming. BIS central bankers’ speeches | bank of italy | 2,011 | 2 |
Remarks by Mr Fabrizio Saccomanni, Director General of the Bank of Italy, at the Federal Ministry of Finance, Berlin, 8 February 2011. | Fabrizio Saccomanni: The European Union and the global crisis the implications for banks, finance and economic policy Remarks by Mr Fabrizio Saccomanni, Director General of the Bank of Italy, at the Federal Ministry of Finance, Berlin, 8 February 2011. * 1. * * Introduction Since the crisis that disrupted the world economy in 2007, financial tensions have affected the eurozone as well. Last year saw moments of crisis in the sovereign debt markets for eurozone countries that threatened to compromise the monetary policy transmission mechanisms. In the international and especially the British and American press, economists and financial analysts hypothesized or predicted sovereign defaults, some countries’ exit from the monetary union, and an end to the euro. Even my old friend Otmar Issing, one of the founding fathers of the euro, in an article in the Frankfurter Allgemeine Zeitung last November that had echoes across the globe, warned governments in the eurozone that the very survival of the currency was at risk. How have we got to this point? Are the risks for the euro really so serious? Can they be mitigated and managed? These are the issues I would like to address today. First, I will recount the phases in the crisis, showing how, after originating in the United States, its repercussions spread to the European Union. I will also describe the situation in Italy, which differs from the other “peripheral” countries in terms of the structure of its economy, the solidity of its banking system and the outlook for the public finances. Second, I will examine why Europe came unprepared to manage a global crisis, lacking the necessary tools and procedures. As has often happened in the history of European integration, the crisis has spurred the EU to adopt a series of measures to strengthen economic governance and crisis management. I conclude by sketching out what I consider to be the crucial items on the European agenda if we are to come through the crisis and promote sustainable growth in the European Union. 2. The global crisis and its impact on the European Union The developments of the financial crisis that struck the world economy in August 2007 are familiar enough, so I will just summarize what to my mind are the main repercussions on the European Union. I will argue that the crisis had three distinct phases, each with distinct implications for the various EU countries. Phase one. The first phase – that of financial “toxic securities” – began in the United States and spread to Europe through the banking systems in which these high-yield, high-risk financial instruments accounted for a large share of financial intermediation. The network of “vehicles” created especially to market these products proved a particularly important channel. Over time, this network had become a veritable “shadow banking system”, operating outside all supervisory control. As was widely reported, during this phase many banking crises required government support measures. Italy was one of the least affected countries, and no Italian bank was placed under public control. The Bank of Italy prevented the creation of any “shadow banking system” in Italy, and banks’ liquidity positions were monitored daily. London’s much vaunted “light touch” approach to supervision was never adopted in our country. Government financial support to banks was a mere 1.3 per cent of 2009 GDP in Italy, as against 51.9 per cent in the UK, 32.2 per cent in Spain, 20.6 per cent in Germany, and 18.4 per cent in France. Italian banks’ recourse to ECB refinancing was extremely modest, even at times of acute liquidity shortages in interbank markets. No Italian bank is featured in the ECB’s list of “persistent bidders”. A number of lessons for regulation and supervision in Europe can be drawn from this phase of the crisis. First, the rules and BIS central bankers’ speeches procedures of banking and financial oversight need to be harmonized in order to avoid disparities in treatment among institutions operating in different countries. Second, we cannot permit substantial volumes of banking and financial business to escape all prudential supervision through recourse to off-balance-sheet transactions and vehicles. Finally, experience has demonstrated the greater efficiency of systems in which banking supervision is entrusted to the central bank. Central banks, in fact, are well placed to detect crises early, because they are in direct daily contact with the money markets and the payments system. Phase two. The second phase of the crisis was marked by the sharp slump in economic activity in 2009. To combat the recession, the ECB adopted a highly expansionary monetary policy, and fiscal stimulus was introduced in almost all EU countries. During this period, the Italian economy was among those hardest hit. GDP fell by 5 per cent in Italy, as against 4.7 per cent in Germany, 2.5 per cent in France, 3.7 per cent in Spain and 4.9 per cent in the UK. The recession was especially hard on the small- and medium-sized enterprises that are the backbone of Italy’s industrial sector, with immediate effects on output and employment. However, the high public debt prevented us from adopting the sort of economic stimulus measures that other countries did. The only available option was to increase the support to unemployed workers. Even so, unemployment in Italy held at about the level recorded in Germany and in France, and well below that in Spain. The lesson of this second phase is the extraordinary success of the economic policies adopted, which effectively limited both the depth and the length of the recession. There were none of the disastrous consequences seen in the Depression of the 1930s, and the recession lasted for just one year. Already in 2010 the whole of the EU saw a sharp upturn. But it was also plain to see that the recovery differed from country to country. Countries with public finances in order and debt at tolerable levels were able to react more quickly and effectively to the recessionary trends triggered by the crisis. Countries like Italy, with a large debt burden, had to limit fiscal stimulus to the utmost and accept a slower pace of recovery. Differences in factor productivity, export competitiveness and labour market flexibility also weighed in. Finally, it was seen how in a globalized system the financial markets have little “patience” for expansionary fiscal policies that are not accompanied by a specific, credible plan to bring deficit and debt down to levels deemed sustainable in the medium term. This kind of “market discipline” does have validity, even if excesses were not lacking. The financial operators, analysts and rating agencies that in 2008 had clamoured for massive monetary and fiscal stimulus to combat the crisis, by 2009 were already voicing worries over the growth in the public debt and calling for an exit strategy, warning of serious repercussions on the markets in the event of delay or hesitancy. Phase three. The third phase of the crisis, in which the EU still finds itself, began with the “discovery” of the critical state of the public finances in Greece in early 2010 and the rapid contagion of most of the European sovereign debt market. Despite the vigorous measures taken by the ECB, the Eurogroup countries and the EU, there were recurrent tensions throughout the year, fuelled by financial speculation and rumours of default by this or that sovereign debtor, the demise of the euro, or the break up of the EU. Again, the impact of the crisis was not uniform. The interest rates on government securities fell in Germany, at times to just over 2 per cent, but rose to record levels in Greece, Portugal and Ireland. Interest rates also increased in Spain and Italy, though less sharply. Italy’s spread, which before April 2010 had been higher than Spain’s, has remained consistently lower since then, confirming the market’s positive assessment of Italy’s public finance management in this phase of the crisis. In absolute terms, since the beginning of monetary union the rate on ten-year Italian government bonds has kept constantly between 4 and 5 per cent, an entirely natural and sustainable level for long-term securities. The market’s assessment also reflects the low level of private debt in Italy, the soundness of the banking system, the high level of households’ real and financial wealth and, finally, the size and diversification of our manufacturing industry, active in all the main sectors. Finally, it takes account of the fact that, based on the multi-year financial stability plan already approved by Parliament, the deficit/GDP ratio should drop below 3 per cent in 2012 and draw close to 2 per cent in 2013, on the way to BIS central bankers’ speeches achieving a balanced budget in the subsequent years. It would appear, in short, that the market considers Italy capable of addressing its structural problems. It is undoubtedly too soon to draw definitive lessons from this phase of the crisis, which is not yet over. But some preliminary observations can still be made. First, the public finances are in better shape in the euro area as a whole than in the other major economies, the US and Japan. The deficit/GDP ratio for the euro area was 6.3 per cent in 2009 and is forecast to fall to 3.9 per cent in 2012. The corresponding figures for the US are 12.9 and 6.7 per cent; for Japan, 10.2 and 8.1 per cent. In 2012 public debt in the eurozone is forecast to reach 88 per cent of GDP, compared with 103 per cent in the United States and 239 per cent in Japan. So we can say that the euro area as a whole does not have the problem of fiscal imbalance. Further, the European balance of payments is in equilibrium and the euro, albeit with some volatility, has held strong against the other main currencies throughout the crisis. However, it must be acknowledged that some euro-area countries do have excessive levels of debt and deficit, which if not properly dealt with could pose risks to the stability of the euro area and the euro. However, the experience of the crisis demonstrated that the EU lacked the instruments either to prevent or to manage problems of this kind. The eurozone could count on the monetary policy of the ECB and the Stability and Growth Pact. The ECB has ensured price stability in the medium term and supplied economies with the liquidity needed for the functioning of the banking and financial systems, but it cannot shoulder the burden of solving problems of public finance without betraying its constitutional mandate. And the Stability and Growth Pact had already been violated before the crisis precisely by the large countries, Germany, France and Italy, which instead should have set the example for the rest. Quite possibly it is unrealistic to expect the EU to handle the risks of financial globalization armed only with a “policy” – strong and efficient, but of limited scope – and a “rule” – clear and simple, but which each country is free to interpret as it sees fit. If we want to preserve our European currency, then, we must expand the European Union’s economic policy arsenal and adapt it to the reality of the global economy and finance. All the eurozone countries must take part in this effort, because the creation of the euro has brought benefits to each. Germany gained a large domestic market free from restrictions and competitive devaluations. In 2009, 61 per cent of Germany’s trade surplus came from trade with the rest of the eurozone; and adding the other member countries, the EU provided fully 87 per cent of the German surplus. When the euro was created, Germany had an external current account deficit equal to 1.4 per cent of GDP; today it has a surplus of 5 per cent. Meanwhile, Germany’s partners benefited from the monetary stability ensured by the euro and lowered their interest rates very close to German levels. The “founding pact” underpinning Economic and Monetary Union has therefore been respected by all; so if imbalances in competitiveness, productivity and the public finances persist, it is up to the European Union to equip itself with the instruments and procedures to induce its member states to eliminate them. Before turning to the possible remedies for the Union’s inadequacies, I would like to sketch the reasons why the EU was caught unprepared to face the global crisis. 3. European construction: forever unfinished? It may well be asked whether the founding fathers of the European Community and then of Economic and Monetary Union deliberately planned to leave the European construction halffinished, with an ambitious and absorbing mission but without the means to accomplish it. Based on the historical record, my answer is no. From the time of Jean Monnet, Konrad Adenauer and Alcide De Gasperi, but also later, with Helmut Kohl, François Mitterrand and Altiero Spinelli, European construction was always conceived as a gradual and pragmatic process aimed at eventually achieving that “ever-closer union among the peoples of Europe” envisaged since the Treaty of Rome of 1957. And this vision was shared by the authors of the Delors Report, all the governors of the European central banks among them, which in 1989 set out the stages for realizing the Economic and Monetary Union. On the occasion of BIS central bankers’ speeches the European Council meeting in Dublin in the spring of 1990, Helmut Kohl and François Mitterrand wrote a letter to their colleagues arguing the need to proceed with political union. In November 1991, in a speech to the Bundestag, Chancellor Kohl said: “Political union is the indispensable counterpart to economic and monetary union. Recent history, and not just that of Germany, teaches us that the idea of sustaining economic and monetary union over time without political union is a fallacy”. In May 2000 Foreign Minister Joschka Fischer, speaking here in Berlin, at Humboldt University, albeit in a personal capacity, lucidly underscored the need to give the EU the effective ability to act by creating a European Federation, with a government endowed with executive power and a parliament wielding legislative power. And I could cite other European leaders. European construction was conceived, then, as a gradual process open to all countries that share its objectives and satisfy certain political, institutional and economic conditions. There was a wide political consensus in Europe on the unwritten principle that the two processes – strengthening the institutions of the Community and enlarging it to new members – had to proceed in step. And the two processes did develop in parallel, in a balanced and harmonious manner, at least until the changeover to the single currency, even though every phase of enlargement was accompanied by a period of intense debate on the Union’s internal rules. This drew European governments’ attention away from the outside world, preventing the EU from playing a significant role on the global political and economic scene. But after the break-up of the Soviet bloc and the creation of the euro, this parallel progress came to an end. Top priority was assigned to enlargement, with no fewer than 10 countries, mostly central and eastern European, included all at once in 2004. The decision had found broad support among governments throughout the EU, albeit not always for the same reasons, but it caused anxiety and concern in the population. Politically, the enlargement meant the end of the historical division of Europe wrought by the Iron Curtain, and in this light it was viewed with great favour, especially in Germany but generally in all the countries. In addition, enlargement meant an expansion of the internal market and, potentially, a “dilution” of the influence of the eurozone continental bloc of countries, a prospect that certainly did not displease the United Kingdom. For the population, instead, the prospect of an open-ended Europe that might include all the Balkans and even Turkey fuelled fear of mounting immigration that would have shattering effects on the labour market and on ethnic and social equilibria. In this context, the effort to strengthen the enlarged EU’s capacity for action did not find political support even in founder countries such as France and the Netherlands. The outcome, in 2005, was the failure of the draft Constitutional Treaty around which a broad consensus had formed in the European Convention. The more modest Treaty of Lisbon, approved by the governments of the Union at the end of 2007, when the global crisis had already begun, did not enter into force until the end of 2009, when the crisis had already unleashed its devastating effects, after a long and difficult process of ratification by parliamentary vote and referenda. An outside observer might find it incomprehensible that the European Union, for fear of the impact of enlargement, deliberately deprived itself of the instruments that would have served to manage the problem better. Actually, as so many times in the history of European integration, the crisis obliged the governments to reopen the “building site” of European construction. In a brief span of time major reform projects have been completed and new initiatives launched that can greatly strengthen the EU’s economic governance. This is not the place to go into the details of what is being done in the “building site”. But I would like to convey the importance of the changes to the institutional framework. Before the crisis, the eurozone’s sole instruments were, as I said, monetary policy and a weak rule, the old Stability and Growth Pact. With the reforms already decided or at an advanced stage of discussion, the EU and the eurozone have adopted instruments for intervention in three important areas: banking and financial supervision, economic and budgetary policy coordination, and crisis management mechanisms and procedures. The first two reforms should improve the ability of the EU to prevent the build-up of unsustainable financial imbalances, and hence the emergence of crisis situations. The third reform will enable crises BIS central bankers’ speeches to be managed in an orderly manner by facilitating the adjustment of disequilibria. Let us briefly see what is involved. The reform of the supervisory architecture. Three new independent authorities have been instituted, responsible for the microprudential supervision respectively of banking, insurance and the financial markets. They began operating on 1 January of this year. Their main task is to make the supervisory rules uniform in the respective sectors and to harmonize the supervisory practices of the national authorities, for the coordinated pursuit of their objectives of intermediaries’ stability, capital adequacy and liquidity. Specifically, the European Banking Authority will also be charged with preparing and conducting a new stress-test of European banks after the exercise conducted last July, which was severely criticized by analysts and market participants for its leniency and lack of transparency. It is absolutely essential that the new test adhere to internationally accepted standards and methods, and that markets be promptly informed of the results; and it is necessary that any bank that fails to pass take adequate measures to strengthen its capital. Alongside the microprudential supervisory authorities, a macroprudential supervisory body will operate at the ECB to monitor systemic risk. The European Systemic Risk Board will analyse the evolution of the credit and financial aggregates to determine whether unsustainable imbalances with systemic implications are being created. The Board will be empowered to recommend to the competent authorities that they take the measures necessary to prevent “speculative bubbles” in the financial and property markets. Economic policy coordination. The changes in this area, designed by the task force under President Van Rompuy, envisage a significant strengthening of budget discipline through a reform of the Stability and Growth Pact and a new mechanism of surveillance on macroeconomic disequilibria and vulnerabilities. The new Stability Pact will stress mediumterm fiscal sustainability and trends in the public debt, imparting operational and quantitative content to the Treaty’s debt criterion. Budgetary coordination will begin each year with the so-called “European semester”, a simultaneous assessment of both the budgetary measures and the structural reforms proposed by the individual member states. The Pact will have both a preventive and a corrective “arm”, plus a broad spectrum of measures and sanctions to apply progressively in each. The new surveillance procedure will stress macroeconomic imbalances and suggest the economic policy measures needed to deal with them; in cases of recurrent non-compliance, sanctions may be imposed. The legislative acts for the institution of these new instruments are still under discussion. It is important, while retaining the objectives, to accord greater operational importance to prevention than to inevitably tardy corrective measures. In any case, it is important that the Commission’s power to issue warnings and recommendations to divergent countries be applied uniformly and not subject to the approval of the Ecofin Council. Crisis management. Under the pressure of global markets, in 2010 the European Union created the machinery for financial assistance to member states in difficulty. At the same time, the ECB introduced a plan of market purchases of government securities to ensure the proper functioning of the mechanisms of monetary policy transmission. After bilateral interventions for Greece, the European Financial Stability Facility and the European Financial Stabilization Mechanism became fully operational, with overall nominal capacity of €500 billion. Naturally, these are mechanisms for conditional support tied to severe adjustment plans agreed with IMF, EU, and ECB. The Stability Facility has already made a highly successful international bond issue to raise funds to support Ireland. These instruments will remain in being until 2013, when a new, permanent mechanism is slated for creation through a Treaty amendment. The new mechanism will be activated by a procedure to determine whether the applicant country is insolvent. If it is, it must negotiate a restructuring of its debt with private creditors and becomes eligible for financial assistance only if the debtor position has been made sustainable. These changes move in the right direction, but so far financial analysts have remained sceptical. They maintain that the Stability Facility does not have the “firepower” for peak needs, if the sovereign debt crisis BIS central bankers’ speeches should spread to major countries like Spain or Italy. I myself consider this scenario most improbable, but I do think it would be good to increase the Facility’s effective size, which is certainly smaller than the nominal amount, and above all to enhance its operational potential. 4. Conclusion The global crisis, with its repercussions on the European Union, is not yet over. There are still strains in the banking systems and the public finances of a number of member states. Uncertainty and volatility continue to beset the financial markets. Economic activity is expanding this year, but growth is expected to slow in 2012 in both Germany and the United States. There is no denying that the prime responsibility for putting their public finances and banking systems in order rests on the single countries. Italy is fully aware of this necessity and will do its part, as it always has. It is just as obvious, however, that countries with a common currency are under a moral obligation to cooperate for the adjustment of the imbalances and to prevent contagion that would destabilize the currency. The measures taken in this regard have significantly enhanced the EU’s capability for effective economic governance even in times of crisis. But the unique European construction is still hard for outsiders to fathom, even those who invest in our financial markets and our currency. So we must make a special effort to communicate better, to make our institutions and procedures more transparent, and to put an end to destabilizing speculative attacks. We need institutional arrangements that are adequate to the economic and financial challenges that the EU and the eurozone will face and that do not require periodic reinterpretation or amendment of the Treaty. Every time the Union reopens Treaty talks, as at present, our partners and the markets wonder whether we are about to take a step forward or a step back. The time for clarity on the economic governance of the European Union is now. Yet the Union cannot solve its structural problems by fiscal consolidation alone. Consolidation is necessary to stabilize the financial markets and to leave more room for private investment. But we must also undertake a strategy of structural reform to increase the European economy’s growth potential, to reduce unemployment, especially among young people and women, and to correct the disparities within the euro area in productivity and competitiveness. These are reforms that can and must be undertaken by all the countries of the Union. This is not the place to set out the details of this plan, which for that matter is specified both in official EU documents, such as the 2020 strategy, and in private writings. 1 In brief, the need is to complete the internal market through further liberalization in services such as mass retailing, transportation, construction, finance and the professions, where the EU lags behind its main competitors. Action is needed for the full integration of energy markets, which are still fragmented at national level and dominated by local monopolies that impose high costs on firms and households. And as the Monti Report notes, we must reinforce the physical infrastructures needed to underpin a huge internal market: the transport and telecommunications networks, the energy grid and the water supply system. Experience shows that these processes of liberalization and integration stimulate research and innovation, which are the prerequisites for new investment and productivity gains. This agenda is ambitious, and in some respects will be unpopular in the short run. It therefore requires strong leadership by the main European players. We have already missed a number of good opportunities – Maastricht, Amsterdam, Nice, and lastly Lisbon – to rise to this difficult challenge. M. Monti (2010), “A New Strategy for the Single Market”, Report to the President of the European Commission José Manuel Barroso, 9 May; G. Amato, R. Baldwin, D. Gros, S. Micossi and P.C. Padoan (2010), “A Renewed Political Deal for Sustainable Growth within the Eurozone and the EU”, CEPS Policy Brief, no. 227, 30 November, Centre for European Policy Studies, Brussels, and EuropEos, Rome. BIS central bankers’ speeches Let me conclude these remarks with the words of a dear friend of mine and an unwavering champion of European integration – Tommaso Padoa-Schioppa, who passed away prematurely in December. In a bitter reflection in 2006, after the failure to ratify the European Constitutional Treaty, Tommaso called on Europe to exercise “active patience”, admonishing us that “completing the construction of a united Europe requires truth and clarity on the basic questions, the rejection of ambiguity, convincing arguments why Europe is necessary both to the prosperity and security of our member countries and to peace and order in the world.” 2 This admonition has lost none of its relevance. T. Padoa-Schioppa (2006), Europa, una pazienza attiva – Malinconia e riscatto del Vecchio Continente, Milan, Rizzoli. BIS central bankers’ speeches | bank of italy | 2,011 | 2 |
Memorial lecture by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the Johns Hopkins University, Bologna, 21 February 2011. | Mario Draghi: In memory of Enzo Grilli Memorial lecture by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the Johns Hopkins University, Bologna, 21 February 2011. * 1. * * Introduction Enzo was not a neoclassical economist, or a Keynesian one, a conservative or a liberal. What I miss most is Enzo’s tendency to challenge intellectual clichés and fads, which made every conversation with him a learning and eye opening experience. He was a truly independent minded person and scholar, passionate at defending his opinions but ready to accept others’ points of view, if based on sound economic thinking or empirical research. He was a strong believer in free trade but also a firm advocate of market regulation. He defended the global institutions at the time of the antiglobal movement but also openly criticized the influence that the main shareholders exert on those institutions. Enzo held important leadership positions both in academic institutions and international organizations. As an official or government representative in these organizations he always resisted political pressures on the decision making process, a factor that made his life difficult on many occasions, but which helped him gain high respect. His brief experience at the Italian Ministery of Budget in the early eighties was one of these episodes. He had a distinctive ability to combine research with actual policy making. In his own words, “the two aspects – theory and economic policy – cannot be distinguished too clearly from each other” 1 . Most of Enzo’s life was spent in the US but he remained passionately attached to his own country with which he communicated mainly through his opinion pieces on the “Sole 24 Ore”. His last book, “Crescita e Sviluppo delle Nazioni” was written in ltalian in order to “enhance also in our country the reflection on economic development, whose presence or absence has fundamental consequences for “humanity” 2 . 2. The environment, economic and institutional Enzo Grilli’s thinking as an academic was certainly influenced by his unique exposure, during his many years at the World Bank and particularly in the mid-nineties, to the debate on the evolution of the world trade system with an increasing number of developing countries. Enzo was a convinced supporter of multilateral trade liberalization. This process culminated at the end of 1994 with the conclusion of the Uruguay Round and the subsequent establishment of the World Trade Organization in 1995. For the first time developing countries committed to partly opening their markets and to well-defined international trade rules; in exchange, they could benefit from more open export markets and a greater possibility to protect their stakes through the new mechanism of trade dispute settlement. However, the Uruguay Round Agreement left open a number of unfinished issues: large agricultural markets in rich countries are still relatively closed; international trade rules are costly to abide by for a number of developing countries; poor countries need foreign aid to develop their supply capabilities and engage successfully in international trade. “Prospettive sullo sviluppo economico dei paesi emergenti”, Banca Popolare dell’Etruria e del Lazio – Studi e Ricerche, 1999. “Crescita e Sviluppo delle Nazioni”, Libreria UTET, Torino, 2005, page VII. BIS central bankers’ speeches The Doha Round of multilateral trade negotiations, which was launched in 2001 was partly devoted to address these issues. Yet, negotiations have been stalemated for a long time. As stressed with foresight by Enzo 3 , the failure to conclude the Round poses dangers, particularly in two respects. Firstly, by inducing as a defensive response a more widespread pursuit of bilateral and regional trade agreements it could result in a loss of bargaining power of the weakest and poorest countries. Secondly, a failure could threaten the very process of rebalancing of the global economy in which the international community is engaged. 3. Enzo Grilli’s analytical contributions Enzo firmly believed that international trade by contributing to economic development could significantly reduce poverty by fostering specialization of national production of goods according to countries’ comparative advantages and by increasing knowledge that would help less developed countries to overcome their significant technological gaps. Enzo stressed particularly two facts. At the global level, greater efficiency of production raises the return to capital. At the national level, trade in capital-intensive commodities tends to equalize the domestic and global return to capital. Both effects stimulate investment, which is an extremely powerful engine of economic growth. The spectacular performance of exportoriented economies mainly in East Asia is a good example of how trade can unleash economic development. The importance of trade was confirmed during the recent crisis. World trade collapsed in 2009 as a consequence of the recession, then recovered to pre-crisis levels, and it is poised to revert to strong trends. World economic integration is continuing. Emerging and developing countries have become engines of growth for the economy of the world. According to World Bank’s estimates about 60 per cent of the increase in world trade in the recovery has been brought about by the rapidly growing demand from emerging countries, especially for capital goods and consumer durables. The surge of those exports has been an important contributor to the recovery in high-income countries, in particular in Germany 4 . In order to help transform the aftermath of the crisis into an opportunity it is necessary to proceed now more than ever to the structural reforms already envisaged by Enzo Grilli in a number of articles. Reforms capable of enhancing high and sustainable growth rates in developed as well as in developing countries, which may also be conducive to rebalancing of domestic absorption in deficit and surplus countries, most notably US and China. 5 He emphasized accumulation of human capital, education and Research & Development as essential elements to raise countries’ productivity and to drive endogenous technological change. In his analyses Enzo devoted much attention to China. To sustain high growth rates, China should move, he argued, on to a new development phase where accumulation of human capital would outpace that of physical capital. In the process a desirable rebalancing of the supply side of the economy (from manufacturing to services) would be coupled with a parallel development on the demand side (a rise in workers’ incomes and in public and private consumption) 6 . Enzo was also a passionate communicator. Whether in an IFI’s boardroom or in a classroom he liked to establish a dialectic exchange with his interlocutors. It was only natural for him to “Ritrovare la spinta del mercato”. Il Sole 24 ore, November 12, 2005. World Bank “Global Economic Prospects”, January 2011. See for example “Sugli USA il peso di tutta la crescita”; Il Sole 24 ore, April 20, 2006. “Cina: la corsa e il rischio di una brusca frenata”; Il Sole 24 ore, September 5, 2006. BIS central bankers’ speeches extend his audience through a regular collaboration with the main Italian newspapers, and since 2002 as a regular contributor to Il Sole 24 Ore. For over a decade he engaged in a dialogue with the public opinion, a fact that, following the example of Luigi Einaudi, was only common to a handful of Italian policymakers and academics. The word “dialogue” truly characterizes his newspapers contributions both for their frequency, almost monthly in his later years, and for their structure, a series of short questions and longer answers, that is mindful of Socratic conversations. The occasional reader was always provided with a key that helped him understand in a plain language the essence of the often complex technical and political issues being debated in international fora. What were the dominant themes of these conversations? Perhaps oversimplifying, I would select three subjects which stand out both for their recurrent nature and for their relevance today. A first subject, raised in his commentaries of G7 meetings or other important international gatherings, was the issue of coordination (or lack thereof) of economic policy decisions by major global players. Here he was often concerned with the inadequate or delayed European response to the global challenges that often left the US as the dominant or the only player. For example, at the time of China’s negotiations for admission into the WTO he complained for Europe’s notable silence or absence at the negotiating table. Similarly he was concerned with Japan’s protracted stagnation, which he attributed to the disconnect of politics from economics in that country, with the result of silencing another important player. A second item of Enzo’s articles was debt management at times of economic crises where he suggested greater market involvement in sovereign debt restructuring through those very Collective Action Clauses (CACs) that are now being considered for future Euro area sovereign debt issues. Similarly, he took strong positions regarding the debt relief proposal for highly indebted emerging countries launched by the then UK Chancellor of Exchequer Gordon Brown and approved by the G7 and the IFIs. His view was that the accumulation of an unsustainable debt is in most cases the result of a wrong policy stance and that debt relief should therefore not be granted if the country had not taken a firm commitment to reverse that stance. A third recurrent subject of Enzo’s articles, not surprisingly, was the IFIs themselves: their effectiveness and their governance. He defended IMF policies during and after the Asian crisis, at a time when the IMF was under heavy attack due to its crisis management strategies on the fiscal and on the monetary front. He claimed that in a world of free capital flows the IMF required a new mandate to be able to effectively pursue crises prevention and management. Such a mandate should encompass new information requirements, additional monitoring powers, as well as access to a broader volume of resources. All these issues are still at the top of the IMF reform agenda. No matter how passionate his defence of IFIs was, Enzo considered IFIs’ criticisms “a normal and even a positive fact” because of the IFIs’ own mandate to pursue public goods with public money. In fact, Enzo was himself often on the critic’s bench, as when he vividly criticized the World Bank for lending to middle income countries without proof that these loans would achieve better and more effective (additional) development results than commercial loans. For those familiar with the aid debate, Enzo’s point was an early call for the certification of “additionality” of aid money. To the IFIs’ governance Enzo devoted a paper, jointly written with another friend that prematurely left us, Riccardo Faini. The question raised by the paper’s title (“Who runs the IFIs?”) was addressed with straightforward intellectual honesty asking the data to reveal whether IFIs’ lending was aligned with the financial and commercial interests of their most influential shareholders. The empirical evidence showed the US influence to be pervasive, while Europe appeared to limit its influence to its trading partners and Japan to Asian countries. Despite the unequal distribution of power, coalitions were nevertheless necessary to run both IFIs. He and Riccardo really foresaw the debate on the reform of the IFIs. BIS central bankers’ speeches Shouldn’t developing countries’ voting power be better aligned with their economic weight? Should the objective of greater weight be pursued by promoting regional initiatives, such as the proposal of an Asian Monetary Fund? Could new broader groups such as the G20 provide a better coordination? After the crisis there is a growing need of coordination of economic policies in order to reduce instability and uncertainty. Several international fora can coexist and usefully complement each other. The G20, even though it has no universal membership, has been particularly effective on a broad set of policy issues even before they are submitted for discussion to the boards of the International Financial Institutions. Recent experience in Europe has also shown how regional institutions like the EFSF can usefully collaborate with the IMF and can greatly leverage the IMF funds. 4. Conclusions These few thoughts about the life and work of Enzo Grilli bear witness of his eclectic approach to discipline of economics, as well as of his intellectual and moral integrity. He once claimed that “economic growth, which is an essential condition for development, is not a mysterious process ( ... )”. Of course, this does not mean to say it is mechanical. In fact, he remarked that “understanding its diffusion ( … ) represents maybe the most important challenge still open”. This calls for a firm commitment to continue the work that he pursued for a whole life. The ultimate goal is “human progress, better quality of life, the chance to free ourselves from the fatal tyranny of ignorance and from the chains of poverty.” 7 “Crescita e Sviluppo delle Nazioni”, page VII. BIS central bankers’ speeches | bank of italy | 2,011 | 2 |
Speech by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the 17th Associazione Italiana Analisti Finanziari-Associazione Italiana Operatori Mercati dei Capitali (The Financial Market Association of Italy) (AIAF-ASSIOM FOREX) Congress, Verona, 26 February 2011. | Mario Draghi: Economic growth outlook, regulatory measures and the situation of Italian banks Speech by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the 17th Associazione Italiana Analisti Finanziari–Associazione Italiana Operatori Mercati dei Capitali (The Financial Market Association of Italy) (AIAF-ASSIOM FOREX) Congress, Verona, 26 February 2011. * * * The economy The world economic recovery is continuing, albeit amidst many uncertainties. Global output grew by 5 per cent on average in 2010; the previous year it had fallen by almost one percentage point. It is commonly believed that the expansion will continue at almost the same pace as last year. In the United States, GDP growth accelerated to almost 3 per cent at the end of 2010; the increase in consumption became more robust. Growth at similar rates is expected for the current year. For the emerging economies, the growth estimate is on the order of an average of 7 per cent this year and next. In the euro area the German economy is providing the strongest impetus for growth, thanks to sharp increases in exports and investment in machinery and equipment. In Italy growth is running at around 1 per cent. The expansion of output is concentrated at exporters, particularly large firms, with outlets in the emerging economies. Domestic demand remains weak, especially consumption, which is affected more severely than in other euroarea economies by uncertain employment prospects and the protracted stagnation of households’ real incomes. The improvement in the world macroeconomic situation and the overcoming of the financial disorder engendered by the crisis are nevertheless accompanied by old and new weaknesses. Sharply divergent growth rates can easily accentuate the volatility of exchange rates and interest rates, jeopardizing the recovery. The interconnections between economies make the system vulnerable even to local shocks. The human dimension and the still uncertain outcome of the popular uprising in Libya are of concern to the international community. The immediate impact of potential problems for energy supplies from northern Africa may be mitigated by the abundant unused capacity of the other producer countries, but the dramatic events we are witnessing may undermine investment in the oil industry in the area and raise energy prices, with repercussions for world growth. For the Italian economy, other things being equal, a 20 per cent rise in oil prices would shave half a percentage point off growth over three years. Economic policies Economic policies have less and less room for manoeuvre. In the last three years the crisis has increased the government budget deficit for the advanced countries as a group by over 6 percentage points of GDP and the public debt by almost 25 points to almost 100 per cent of GDP. In the United States and Japan fiscal consolidation can hardly be put off any longer: the OECD considers that just stabilizing the debt ratio of these two countries within the next fifteen years would require a correction of the primary budget balance on the order of 8–9 percentage points of GDP. In Europe we are already working to reduce the imbalances in the public finances. The strains that affected the BIS central bankers’ speeches sovereign debt of some of the euro-area countries have focused attention on the risks of prolonged imbalances. The euro area’s budget deficit is expected to improve sharply this year from 6.3 to 4.6 per cent of GDP according to the European Commission’s latest estimates. The debt ratio is likely to rise further, but much more slowly than in the last two years. In Italy the ratio of public debt to GDP, close to 120 per cent, should begin to decline next year, when the Government intends to bring the deficit down to below 3 per cent of GDP. In the ten years preceding the crisis, current expenditure, net of interest on the public debt, grew by 4 per cent per year in nominal terms, far outpacing GDP. Last September’s Public Finance Decision forecasts that its increase will be limited to 1 per cent per year in 2011–12. This trend must continue beyond 2012 and the composition of primary expenditure must be geared to growth. There is no other way to reduce the deficit, since the burden of taxes and social security contributions is already 3 points above the euro-area average. Additional revenue that comes in as a result of the reduction of tax evasion should be used to ease the burden on the taxpayers who already pay what is due. It may also be necessary to offset at the central government level any increases in decentralized taxation caused by fiscal federalism. The financial aid that Greece and Ireland received last year from the European Union and the IMF was conditional on their enacting strict fiscal consolidation plans and incisive economic and institutional reforms. A major contribution to preventing new sovereign debt crises should come from the reform of European governance now under discussion, which aims to strengthen multilateral surveillance of national economic policies. It is important that semi-automatic rules come into play when deviations from the agreed parameters occur, as this will drastically reduce the chance of their being evaded. Rescue funds should be used only in emergencies and, as IMF experience suggests, should be tied to rigorous adjustment programmes. Monetary policy faces different situations in different parts of the world. In the emerging countries, good growth prospects and high yields are attracting abundant inflows of private capital from abroad. In 2010 these amounted to around $900 billion, equal to almost 5 per cent of these countries’ GDP. At a time when demand is already expanding rapidly and the financial system is not yet well developed, such inflows can cause high inflation and financial bubbles. The inflation rates already recorded in these countries – about 6 per cent on average and well over 4 per cent in China – are partly due to the higher cost of food and energy products, although the acceleration in domestic demand also plays a part, since it is behind the jump in international commodity prices. These increases, which are particularly hard on the poorest, could be countered by currency appreciation, which is necessary in any event in order to reduce global payments imbalances. In the absence of such appreciation, monetary policies in these countries are becoming more restrictive. In the advanced economies inflation is dampened for the time being by the ample margins of spare capacity. In the United States, the Federal Reserve recently confirmed its plan of last November to increase liquidity by purchasing Treasury paper. In the euro area, consumer price inflation, driven up by the sharp rises in commodity prices, in January widely overshot the definition of price stability fixed by the ECB Governing Council. Core inflation remains low, given the moderate growth in domestic costs and a cyclical recovery proceeding without any spurts. Inflation expectations over the medium term remain well-anchored. However, the appearance of inflationary tensions does require that we carefully assess the timing and methods for restoring normal monetary conditions and interest rates. Monetary policy must prevent a deterioration of expectations, in order to keep the stimulus of international prices from passing through to domestic prices and wages in the longer-term. BIS central bankers’ speeches Real short-term interest rates that are markedly negative, as they have been over the past two years, have not improved the growth prospects of the less dynamic economies. As economic policies reach the end of their expansionary phase, this will not necessarily endanger growth. In the weakest countries, in particular, the cost of borrowing could benefit from the narrowing of spreads on government securities following the adjustment of budget policies and from the containment of risk premiums as inflation expectations are kept under control. International financial rules and controls Considerable progress was made last year in building a more robust international financial system, better able to withstand crises. The Basel III regulatory framework was drawn up, with new capital and liquidity requirements and limits to financial leverage. Its gradual phasing in will prevent it from impeding economic recovery. The over-the-counter derivatives markets will have a sounder and more transparent basis, with greater standardization of transactions, the requirement to use central counterparties for standardized contracts, and full and prompt access to data for the authorities. We have identified many of the perverse incentives that encouraged excessive risk-taking – in banks’ executive compensation systems, in the role of rating agencies and in the accounting rules – and begun to rectify them. But much still remains to be done. The activity of the Financial Stability Board is now concentrating, in accordance with the mandate given by the Seoul Summit of the G20, on the moral hazard problem posed by systemically important financial institutions (SIFIs), those that in the latest crisis and earlier ones were considered too large, or too complex and interconnected, to be allowed to fail and that have often received injections of public capital. Knowing that they cannot fail encourages them to take greater risks, while the markets finance them at lower interest rates than they apply to intermediaries exposed to the risk of failure. The ability to wind up these institutions without undermining the markets or using public money, the certainty that they can absorb larger losses than those that less important intermediaries can bear, and more extensive and penetrating supervision; these are the three pillars on which the FSB’s recommendations will be based. Within the year the Board will publish the essential features of national rules for the winding up of SIFIs, a framework for the restructuring and winding up plans that every SIFI must prepare, and a preliminary analysis of the questions involved in the international coordination of laws on this matter. It will then be up to governments and parliaments. By the middle of this year we plan to have established the parameters for identifying global SIFIs, to which to start applying more rigorous prudential rules. The criteria will include not only the size of intermediaries but also the extent to which they are interconnected with others and their importance in specific segments of the financial market. The necessary discretion to be left to national authorities in applying the criteria will have to be balanced by peer reviews starting at the end of 2012. SIFIs’ ability to absorb losses needs to be improved in order to minimize the probability and systemic impact of a crisis; the measures to this end include capital requirements additional to those laid down by Basel III. There are various possible techniques: higher ordinary capital ratios, the participation of some creditors in losses (bail-in) and debt instruments that convert into common equity on the occurrence of specific events (contingent capital). Another field for action by the FSB concerns the “shadow banking system”. We are preparing a map of the non-bank activities and intermediaries that, insofar as they create credit and transform maturities, need rules and supervision similar to those of the regulated banking system. BIS central bankers’ speeches The new European supervisory bodies are now operational. The first task, in which the European Banking Authority will be primarily engaged, is to carry out stress tests on the leading banks. The tests will have to satisfy four requirements: very severe scenarios; strict assessment of the results using a common methodology and backed by thorough peer review; complete transparency; and prompt identification of the remedial measures. The requirements are essential for the credibility of the exercise and the markets’ assessment of the European banking system. Harmonization of the prudential rules is the other urgent object to achieve. A set of common rules – the single rulebook – will help to prevent less strict supervisory rules and practices in one country from jeopardizing the stability of the European financial system, having repercussions on the economies of other countries and distorting competition. A first test will be the implementation in Europe of the Basel III rules. All the countries of Europe have pledged to transpose those rules into law, in keeping with rigorous principles, already present in our model of supervision, whose validity was confirmed in the course of the crisis. The European Systemic Risk Board, charged with signalling areas of risk and making recommendations, will need to be able to accompany its analyses with effective intervention measures. It will avail itself of systemic stability risk assessments shared with the microprudential supervisory authorities. Italian banks and the Bank of Italy’s supervisory action The money and financial markets are now functioning better, but the return to complete normality will take time. Banks, particularly European banks, are having difficulty raising funds in the market. Their balance-sheet assets are exposed to significant risks stemming from the after-effects of the recession and the strains in the sovereign debt markets, which give rise to liquidity risk and the possibility of capital losses. With the financial crisis, the global environment in which Italian banks operate has been altered. Competition for funding, including competition with sovereign borrowers, has become fiercer. The structural contraction in the volume of assets in some capital market segments has brought a permanent decline in income. In the closing months of 2010 the main Italian banking groups’ net liquidity position one month ahead remained positive, on average, but shrank. In January, however, they made bond issues worth some €10 billion, or about one fifth of the wholesale funds maturing in 2011. Short-term funding capacity also showed improvement, although the volume of these placements remains smaller and the duration shorter than before the sovereign debt crisis. Maintaining adequate reserves of liquidity is vital to safeguarding stability and continuing to provide finance to the real economy, especially while the market is still vulnerable to sudden crises of confidence. Prudence must not be sacrificed to profitability. In 2008, in the thick of the financial crisis, the fall in the earnings of Italian banks due to writedowns of securities, trading losses and reduced fee income was quite modest compared with the severe losses suffered by banks elsewhere. But since 2009 the situation has changed. Italian banks’ profits are weighed down by a contraction in net interest income and a deterioration in loan quality, the consequence of the severe economic recession. In the first nine months of last year the earnings of the five largest groups declined by 8 per cent compared with the corresponding period of 2009. Return on equity fell below 4 per cent on an annual basis. In two years net interest income has fallen from 2.0 to 0.9 per cent of total assets, owing to the slowdown in lending and the decrease in the mark-down on sight deposits caused by the low level of interest rates. Value adjustments to loans, though lower than their 2009 peak, continue to absorb more than half of operating profit. The average balance-sheet cover ratio for impaired loan assets remains below its long-run level. The recovery in margins is also slowed by the heightened competition for retail funds. BIS central bankers’ speeches In recent months a country-risk effect has been added. Today Italian banks, even the most efficient, are penalized in fund-raising on the wholesale markets. They pay about 70 basis points more than their German counterparts. The low profitability of Italian banks reflects not only the sluggishness of the Italian economic recovery but also their prevalent business model: concentration on lending to retail customers (households and small businesses); retail fund-raising; low leverage; limited securities trading on own account; and less maturity transformation than banks in other countries, owing in part to the predominance of variable-rate loans. This model means our banks are less exposed to financial market volatility and protected them during the crisis. The other side of the coin is that it makes them heavily dependent on net interest income and macroeconomic conditions. It makes their operating costs more rigid. Resolute action is needed to lower the ratio of costs to total income. In recent years the largest Italian banks have enhanced their operating efficiency, bringing the cost/income ratio closer to that of their European competitors: 62 per cent, against an average of 58 per cent for all EU banks in the first half of 2010. Italian banks must improve further, and decisively, by rationalizing sales networks, extending and refining the use of technology, simplifying the structure of production, selling other non-strategic assets, and adapting compensation policies at all levels. Curbing costs will permit the recovery in profits needed for the capital strengthening that the markets and the new capital rules demand. Given the difficulty of raising fresh equity capital, it is essential to generate sufficient resources internally. The capital ratios of the top five Italian banking groups are rising overall. At the end of September the tier 1 ratio stood at 9.0 per cent, while core tier 1 capital came to 7.9 per cent of risk assets, up from just 5.7 per cent at the end of 2007. On average Italy’s smaller banks already have levels of capitalization in line with the new regulatory minimums set by Basel III. These banks supply more than half the credit needs of the country’s small and medium-sized enterprises. For the major banks, which use internal rating models, the Basel II rules for containing the capital charges for loans to smaller companies stand confirmed. This year we shall again assess the resilience of Italian intermediaries in the face of highly adverse conditions, as part of the new series of stress tests of the European banking system. Thanks to the experience gained to date, the Bank of Italy and intermediaries will be able to interact fruitfully for the success of this new exercise. For banks to be prepared when the new capital adequacy rules are fully phased in, capital strengthening must proceed, above all through retained earnings. We expect that as in 2009 a large part of last year’s profits will be allocated to increasing the banks’ capital. Nevertheless, recourse to the capital market would also appear unavoidable as soon as conditions permit. Another major structural change in Italian banks’ business environment involves consumer protection, which is considerably stronger today than in the past. In recent years the Bank of Italy has stepped up its work to improve banks’ customer relations. We have acted on several fronts: new rules, intensified controls, new consumer protection instruments. We have always favoured the elimination of the distortions that put the Italian banking industry at a disadvantage vis-à-vis the competition. The Government’s recent initiatives concerning the tax treatment of banks go in this direction and respond to long-standing requests of ours. But we are just as strongly convinced that the Italian model of banking, given the nature of banking customers, has a greater need than others for customer relations to be based on transparency. Any retreat on this front will encounter the Bank of Italy’s firm opposition. BIS central bankers’ speeches Growth The essential objective remains growth – growth that is equitable and pays heed to the quality of life. Without growth, financial stability cannot be consolidated in the world, in Europe, or in our country. The Monetary Union can overcome the sovereign debt crisis of some of its members if it is able to reach agreement not only on the ways to ensure fiscal discipline but also on the structural reforms needed to impart enduring impetus to growth and on the forms of mutual control over their implementation. In Italy, growth has been languishing for fifteen years now. We have dwelt on the underlying causes and the contours of reform action in various venues, on the basis of the analyses that we have conducted in recent years. Let me recall some of them. The growth of the whole economy would benefit from a legislative overhaul keyed, pragmatically, to enhancing the system’s efficiency. If legislation is not transparent, welldesigned and stable, if the administrative burdens are disproportionate to the activities regulated, in the long run the economy will decline. Despite the progress made, Italy still stands out in all the international rankings for the burdensomeness of its bureaucratic obligations, especially those incumbent on firms. The educational system is decisive. The achievement gap between our students and their peers in other countries has narrowed but remains wide, and it is particularly large in the South. The school system must reward academic merit and diligence. It must guarantee a satisfactory level of education to all students, irrespective of their social background and geographical origin. Our university system, despite some notable exceptions, is still far from the standards of quality prevailing in most of the advanced countries. Our research institutions are unable to attract talented scholars, technicians and managers, Italian and not, in sufficient numbers. Recognition of merit is one of the central principles of the reform of the university system just approved. This is a first step in the right direction. For over a decade the entry wages of young people in the labour market have been stuck below the levels of the 1980s in real terms. The recession has made the situation more difficult. The youth unemployment rate verges on 30 per cent. Already high by international standards, young people’s dependency on their parent’s wealth and income, a factor of conspicuous social inequity, has been accentuated. A major contributory factor is the segmentation of the Italian labour market, where the rule is minimum mobility at one extreme and maximum precariousness at the other. This is a waste of resources that mortifies young people and seriously impairs the efficiency of the productive economy. Our firms’ propensity to innovate and their international projection are insufficient to drive growth, ultimately because too many firms remain small, including successful ones. The conduct of entrepreneurs also reflects improper incentives not to grow. A tax system with less evasion and lower rates would be conducive to firms’ decision to scale up and to accept contributions of new equity capital. As we have seen on several occasions, the North-South gap in Italy depends largely on national policies and their application at local level. We can regard the possibility of a reform drive with fair confidence. Italy possesses abundant resources, has many companies, entrepreneurial ability and a hardworking and thrifty people. It is a matter of freeing the spirit of entrepreneurs and individuals from many constraints. This has already begun, but bolder reform measures would improve the expectations of firms and households and would give a boost to growth. This year we celebrate the 150th anniversary of the birth of a united Italy. More than one third of our history has been characterized by the choice – more and more deeply felt with the passage of time – to be part of Europe in every phase of its integration. We have made no small contribution, and received no little in return. More than in the past, the strategic choices that we face as Italians and as Europeans now coincide. To transform this awareness into action shared by citizens is the noble task of politics in Europe. BIS central bankers’ speeches | bank of italy | 2,011 | 2 |
Introductory comments by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the VIth International Symposium of the Banque de France on "Which regulation for global imbalances?", Paris, 4 March 2011. | Mario Draghi: Challenges of surveillance and coordination Introductory comments by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the VIth International Symposium of the Banque de France on “Which regulation for global imbalances?”, Paris, 4 March 2011. * * * The recent crisis has greatly raised our awareness of two processes that have been shaping the world economy: first, the growing interconnections between economies, that make the global system vulnerable even to local shocks; second, the move towards a multi-polar setting in which no single dominant politico-economic power exists and new subjects, such as the fast-growing emerging economies, are coming to the fore. Both processes are a reflection of fundamentally benign developments, such as free trade, free capital movements and the spreading of technological innovation which have brought enormous benefits to the world economy. However, as the crisis has forcefully shown, the potential for inherent instability is greater; and the damage that may result from this instability is too large to ignore. In the past decades, after the end of the Bretton Woods regime, weak forms of policy cooperation prevailed. In terms of the international monetary arrangements in place, it was a “non-system”. For a long time, stronger forms of international policy coordination were deemed unnecessary: many theoretical and empirical analyses in the 1980s converged to show that any gains from such macroeconomic coordination were likely to be of modest size. However, we may now need to revisit that fairly sceptical conclusion. In the new global environment, policies (and policy errors) in individual economies can have substantial spillover effects. Moreover, the costs of uncoordinated policies may increase in a non-linear fashion if those policies lead to large systemic breakdowns. In my view there is one main, simple lesson we should take from the crisis: if we want to preserve the gains brought by open, competitive markets on a global scale, we need stricter and more effective international cooperation. The common response to the crisis was a quantum leap forward in international economic relations. With a coordinated, prompt and synchronous set of policy measures we managed to avoid the worst consequences for the global financial system and the world economy. As the situation improves, it would be naïve to think that we can now go back to the previous loose coordination. There continue to persist underlying “fault lines” (to use the words of Raghuram Rajan) that pose significant risks at the global level: an uneven recovery, diverging economic policies, protracted low levels of interest rates, increased sovereign debts, large imbalances in international payments, and pressures on exchange rates. Correspondingly, we should continue to improve international cooperation. There are three main priority areas: – first we need to complete the reform of the international financial system; – second, we have to develop a better system of macroprudential surveillance, refining the authorities’ ability to identify systemic risk and, especially, to act upon early warnings; – third, crucially, we need to establish a coherent set of norms, rules of conduct and formal institutions shaping coordination of national economic policies. We have come a long way towards strengthening the financial system since the crisis began. My own experience in the Financial Stability Board is that it is certainly possible – at times BIS central bankers’ speeches even surprisingly easy – to come to a shared diagnosis and devise a common response even to extremely complex problems, when there is a willingness to do so. The new Basel III regulatory framework is now in place, with new capital and liquidity requirements and limits to financial leverage. Its gradual phasing-in will prevent it from hampering the economic recovery. The over-the-counter derivatives markets will have a sounder and more transparent basis. We have identified many of the perverse incentives that encouraged excessive risk taking – in banks’ executive compensation systems, in the role of credit rating agencies and in accounting rules – and we have begun to rectify them. The activity of the FSB is now concentrating – in accordance with the mandate given by the G20 – on two crucial priorities: tackling the moral hazard problem posed by systemically important institutions (SIFIs) and extending the rules to the “shadow banking system”. The reform of the financial system is however not complete. There is a danger that, as the world economic recovery advances, the sense of urgency – a major propeller so far – might now weaken. It would be unforgivable not to keep the momentum in international cooperation and miss the occasion to decisively strengthen the international financial system. There are two obvious compelling reasons for this. First, neither our public finances nor our citizens would be ready to withstand a new crisis. Second, in a global system where external imbalances remain large and capital flows may be subject to sudden reversals, it is essential to rely on a financial system that is at the same time efficient and more robust, immune to the perverse incentives that led to the accumulation of excessive risks that generated the crisis. Consistent implementation of the agreed reforms at the national level is the arena where the effectiveness of international cooperation will be tested. In the absence of a global enforcer the only practical way forward is to strengthen both the peer review process and the reach of international institutions, in primis the IMF, which retains the responsibility for surveillance over the global financial system. Significant progress has also been made in setting up top-down, system-wide oversight arrangements at the national, regional and international levels. These arrangements are designed to deliver more encompassing surveillance, with broadened macro-prudential perspectives and better mechanisms for triggering actions on identified risks. Examples include the European Systemic Risk Board in Europe, the Financial Services Oversight Council in the US, and the IMF-FSB Early Warning Exercise to assess macro-financial risks and systemic vulnerabilities at the global level. A lot remains to be done in this, in many respects, unchartered territory. We now need to improve analytical tools, design instruments of intervention, elaborate organizational arrangements by which the different authorities can effectively share information and, especially, coordinate actions to prevent and to manage critical situations. A painful lesson of the recent crisis – and the many preceding it – is that the authorities did too little to act upon “early warnings” that, though weak and imprecise, were often clear enough to have warranted more forceful preventive action. Challenges even more severe lay ahead on the macroeconomic policy front. Here the risk is very tangible that, with the emergency now over, a purely domestic orientation again prevails in economic policy decisions – a tendency of which some signs are unfortunately already evident. The consequence would be larger imbalances, increasingly erratic capital flows, and greater exchange rate volatility – all factors that ultimately can hamper the recovery. It is imperative to resist such tendencies and abide to the pledge – repeatedly stated by the G20 – to work together to ensure a lasting recovery and set the world economy on a path of strong and sustainable growth. A “new Bretton Woods” is perhaps a rhetorical exaggeration but we do need a common realization that the present, weak cooperation arrangements for managing the world economy are inadequate. Greater interdependence requires stronger policy cooperation and some form of disciplining mechanism to ensure that national policies are mutually consistent. Stronger cooperation in turn necessarily presupposes an agreed set of benchmarks and BIS central bankers’ speeches rules in all the relevant fields. Individual economies should not only continue to “keep their own house in order” – which is probably at this point a still necessary, but insufficient condition. They must also be induced to take more fully into account the global effects of their own policies, whose mutual consistency needs to be ensured. To achieve this objective we need a decisive improvement in the governance of the international monetary system, addressing those problems that have hindered its proper functioning. The central issue is, in my view, the need for a more effective process of multilateral surveillance over national economic policies. Some steps forward are being taken. The “legitimacy deficit” of international bodies has been at least in part addressed with the agreement on the IMF quota reform at the Seoul summit of November 2010; the very same leadership role taken by the G20 in international economic affairs is a recognition of the need to increase legitimacy and representation. The IMF has been given more resources and more incisive monitoring power, for example by making FSAPs compulsory for all systemically relevant members over a 5-year cycle, and is enhancing its traditional machinery for surveillance (bilateral and multilateral). In parallel the G20 is proceeding with its own peer review process (the Framework for Strong, Sustainable, and Balanced Growth) to identify objectives for the global economy and the policies needed to achieve them. The evaluation of the mutual consistency of such policies is the goal of the “Mutual assessment process” (MAP). The MAP requires an assessment of the nature and the root causes of impediments to the adjustment of persistently large imbalances and indicative guidelines, composed of a range of indicators, to facilitate a timely identification of imbalances that require preventive and corrective action. This is an essential and, at the same time, a very demanding task. As agreed by the G20, there must be a shift to a more balanced global pattern of demand. Some progress in this direction is being made, but important challenges remain. Emerging market countries of systemic relevance ought to prioritize structural reforms and greater exchange rate flexibility to strengthen domestic demand; further fiscal consolidation is necessary in advanced countries, based on growth-friendly measures; finally, all G20 members should implement product and labour market reforms to boost their potential output. It is also to be welcomed that both the IMF and the G20 under the French presidency have started ambitious and comprehensive discussions on possible avenues for the reform of the international monetary system. Let me conclude by saying that in all the above fields Europe can and should bring to the international debate a wealth of experience. In Europe, we have come – in some cases rather belatedly – to the realization of the close interdependence among our economies and of the consequent need for effective rules and governance. The single currency is acting as a powerful device to reinforce surveillance, coordination and the peer review process in an institutional setting where economic policy decisions remain to a very large extent in the national domain. This makes Europe a natural laboratory for experimenting solutions that can be of use at the global level as well. BIS central bankers’ speeches | bank of italy | 2,011 | 3 |
Address by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the Catholic University of the Sacred Heart (Università Cattolica del Sacro Cuore), Milan, 21 March 2011. | Mario Draghi: The euro – from the past to the future Address by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the Catholic University of the Sacred Heart (Università Cattolica del Sacro Cuore), Milan, 21 March 2011. * * * The euro: an idea that goes back a long way The idea of a single currency, in place of a congeries of local or national monies, did not gain much ground in modern Europe until the second half of the nineteenth century. Why was that? It would be natural to think that a universal currency is a timeless aspiration: to extend the traditional functions and therefore the advantages of money in the widest geographical sphere. A possible explanation is the redistributive use that money had been put to over the centuries: in classical antiquity and then in the Middle Ages, adjusting the currency – increasing or reducing the gold or silver content of metal coins – was often a way for the prince to appropriate resources; striking coins was an attribute of sovereignty. It took a long time to reach the point, in the nineteenth century, when the value of a monetary unit was defined solely by the quantity of precious metal it contained; paper money was declared convertible into metal; money had been “depoliticized”. Thinking up monetary unions then became a possible exercise, as long as the candidates had the same standard: gold, silver or bimetallic; it was sufficient to agree on the fineness, the weight and the denomination of the coins to be put into circulation. A union of this kind, the Latin Monetary Union, inaugurated in 1865, brought together Italy, France, Switzerland, Belgium and Greece, but it had a difficult life and broke up, as a practical matter, at the beginning of the next century. The monetary unions realized within federal states – the Swiss and the German ones – fared better. But the use of the currency for redistributing wealth did not come to an end. Despite the establishment and consolidation of technical institutions – the central banks – delegated to manage the issuance and circulation of money, the currency reverted, at least in wartime, to being an instrument of state financing. The transition to paper money facilitated this process. During the First World War, the Governor of the Bank of Italy, Bonaldo Stringher, noted that the Bank of Italy “has given a stimulus to banknote production equal to that received by the machine shops producing bullets”.1 In the 1920s and 1930s, marked by the Great Depression, the monetary instrument was returned, with the contribution of Keynes, to the toolkit of economic policy. The potential of this instrument prompted the central banks and the governments that controlled them to make ample use of it to manage the economic cycle but also as a means of more or less openly supporting the public finances. The height of this era was reached in the 1970s, a decade of high inflation. In Europe the Bundesbank basically protected the German economy from these excesses. There ensued a reconsideration of the role of the central banks and the objectives and instruments of monetary policy, whose findings would be used extensively in the period that followed right up to today. In the 1950s the ruinous effects of the Second World War spurred a revival of interest in integration among the European economies, which would simultaneously be a means of promoting growth and ensuring peace. The creation of the European Common Market accompanied the period of the fastest economic growth ever experienced on the Continent. Banca d’Italia, Adunanza generale ordinaria degli azionisti, year 1918, p. 49 (only in Italian). BIS central bankers’ speeches To buttress these results and, almost in a utopian spirit in the midst of international monetary disorder, plans were made for the single currency. The 1970 Werner Report was the first official plan for European monetary union and, while it was never implemented, it paved the way twenty years later for the Delors Report, which, basing itself on the still limited experience of monetary cooperation realized in the meantime (the “snake” of the 1970s and the European Monetary System of the 1980s), planned the creation of the euro. This was made possible by an altered cultural climate, which viewed the independence of the central banks and price stability as the fundamental values upon which to base a sound currency. The plan was propelled by personalities from a generation that harboured the memory of the ruins of war: Andreotti, Ciampi, Delors, Giscard d’Estaing, Kohl, Mitterrand and Schmidt, who were flanked by figures from the next generation, like Tommaso Padoa-Schioppa. The Maastricht Treaty of 1992 created the institutions of modern monetary Europe, establishing the passage of monetary sovereignty to the European System of Central Banks. The System’s objective was defined clearly and with legislation having constitutional status – taking a leaf from the German experience – as maintaining price stability, a value that became the common heritage of all citizens of the area. From this followed the basic principle that governments must not interfere in monetary policy; monetary financing of states was prohibited. The euro has been with us since 1999 and, as an actually circulating currency, since 2002. To achieve this outcome, in many countries major political obstacles had to be surmounted. In Italy, it was necessary to overcome society’s inurement to devaluations and inflation. There was no lack of academic scepticism, including from the other side of the Atlantic. There were doubts about the European economies ever being able to constitute an optimal currency area in Mundell’s terms. The European monetary construction works. The euro is not in question. The first twelve years of the euro Today the euro is the second most important currency in the world: it accounts for 27 per cent of global currency reserves; before the Union, the currencies replaced by the euro together accounted for 18 per cent. Between 1998 and 2010 the total value of imports and exports of goods within the euro area rose from 27 to 32 per cent of GDP. The greater volume of internal trade was not at the expense of that with the rest of the world, which recorded an even sharper increase, from 25 to 33 per cent, driven by the expansion of the emerging economies, more and more open to world trade. Integrated infrastructures were created for payments in the area: for wholesale and retail payments and, in the near future, for the settlement of securities transactions. Between 1999 and 2008 the average daily volume of cross-border payments between euro-area countries via TARGET increased by almost 250 per cent; the average total volume of transactions, which includes domestic payments, grew by more than 120 per cent – more than four times greater than the growth recorded by the equivalent infrastructure in the United States. Price stability is inscribed in the conduct of economic agents, even in countries which were previously the most inflationary, enhancing the legacy of the best traditions of the participating central banks. In the twelve years of the euro, annual inflation in the area has averaged just under 2 per cent, fully in line with the definition of price stability adopted by the Governing Council of the European Central Bank (ECB). It has fallen by more than one half compared with the previous two decades; the reduction was greater than that seen in the United States in the same period. In Italy, the average annual increase in consumer prices BIS central bankers’ speeches was five percentage points lower than in the twenty-year period preceding the introduction of the euro. Today exogenous price shocks have modest repercussions on the euro-area economies: the increases in oil prices between 2007 and 2008 were comparable, in real terms, to those at the end of the 1970s, but they generated a one-off rise in consumer prices of less than two percentage points, which did not take hold in inflation, in contrast to what happened in the past in several countries in the area. According to our estimates, the inflationary effect in Italy of a shock of this kind has been reduced to one tenth of what it was in the 1970s. Of course, structural changes in production processes have played a part, but the credibility earned by monetary policy and the resulting changes in price and wage setting have played a crucial role. Price stability and low risk premiums lead to low nominal and real interest rates, thereby fostering economic growth. From the introduction of the euro to today, the real three-month interest rate in Italy has averaged 1 per cent, four percentage points lower than in the previous decade; the average nominal rate on bank loans for house purchases and that on short-term loans to non-financial firms have averaged 4.5 and 5.5 per cent respectively, compared with 11.3 and 12.6 per cent in the ten previous years. It is surely not the monetary conditions that are responsible for the growth difficulties of the Italian economy. Again with reference to the twelve years of the euro, annual expenditure for interest payments on Italy’s public debt averaged 5.3 per cent of GDP, against 11.5 per cent in the first half of the 1990s and 7.5 per cent in the 1980s. It is still the case today that, despite strong pressures on the government securities markets of some of the countries of the area, the yields on Italian ten-year securities are in line with the averages recorded in the last decade. The response of euro-area monetary policy to the global crisis of the last three years was rapid and decisive. Inflation expectations held firm even at the height of the crisis, allowing us to take action to keep the markets working, support lending and avert the collapse of the economy. Money market rates were reduced to close to zero; exceptional liquidity creation measures were adopted. Without the Union, simply coordinating national decisions would not have produced such rapid and effective results. Some countries, including our own, could have been overcome by the crisis. But the credibility we have earned will not necessarily last for ever; we have to remain vigilant in safeguarding price stability. The culture of stability must also be extended to other fields: to fiscal policy, to structural reform where weaknesses have emerged in the European construction, as they did clearly during the recent sovereign debt crisis. The sovereign debt crisis of some euro-area countries The strains spread outwards from Greece, where they had been generated by the disorder of that country’s public finances, and hit the Irish and Portuguese government securities markets last spring. Spanish and Italian government bonds have also seen their yield spreads widen with respect to the corresponding German securities. The response of the European institutions and governments has followed a rough path. The financial support plan for Greece, agreed at the beginning of May 2010 by the euro-area countries with the European Commission and the IMF, did not eliminate the tensions, which, on the contrary, spread to the stock, bond and interbank markets. To contain the contagion risk posed to other countries, several days later the EU Council instituted a financial stabilization arrangement under which the countries of the area could get a loan at analogous conditions to those applied by the IMF in similar circumstances. It BIS central bankers’ speeches was decided that the bulk of the resources would come from the European Financial Stability Facility (EFSF), a new body authorized to fund itself on the market by issuing securities guaranteed by the countries of the euro area. In the same days a number of countries adopted or announced drastic plans for the consolidation of public finances. In the same month of May 2010, the Governing Council of the ECB came to the conclusion that the tensions in the markets were compromising the monetary policy transmission mechanism. It launched the Securities Markets Programme of purchases of public securities issued by euro-area countries with a view to supporting market segments hit especially hard by the crisis; and it confirmed its commitment to supply abundant liquidity to the system. This did not imply the monetary financing of sovereign states or the creation of liquidity; the interventions were temporary and sterilized. This set of measures stemmed the tensions, which nevertheless began to intensify again during the summer and even more in the final part of the year, once more affecting not only Greek bonds but those of Portugal and especially of Ireland, which had issued a government guarantee for all bank liabilities. At the end of November the EU finance ministers approved a plan of financial support for Ireland. This measure too helped to allay but did not eliminate the tensions, in a context of elevated uncertainty in the markets regarding the prospects of stabilization in the countries hit by the crisis and the possible interconnections between sovereign risks and the vulnerability of some banking systems. The crisis originates from imbalances that in some countries concern the public finances, in others the banking system. Overcoming the difficulties first requires drastic, resolute national measures. The stance of monetary policy has been expansionary for a long time: since May 2009 the Eurosystem’s reference interest rate has held at 1 per cent, an exceptionally low level; real short-term rates have remained negative by a wide margin even after the start of the cyclical recovery. The emergence of inflationary pressure calls for a careful evaluation of the timetable and manner in which to proceed with a normalization of monetary conditions. A deterioration of expectations must be prevented, to keep the impulse originating from international prices from being transmitted to domestic prices and wages and thereby influencing inflation beyond the short term. As President Trichet recalled on the occasion of the meeting at the beginning of March, the Governing Council of the ECB remains prepared to act in a firm and timely manner to ensure that these risks do not materialize. We are following the tragic events in Japan with the closest and most heartfelt attention. The exchange rate interventions agreed on 18 March by the finance ministers and central bank governors of the G7 countries are intended to prevent excessive volatility of exchange rates from having adverse effects on economic and financial stability. A construction to be strengthened The sovereign debt crisis has brought to light at least two factors of fragility in European construction. In the first place, the rules did not avert imprudent fiscal policies in some countries, which were either unable or unwilling to exploit the positive phases of the economic cycle in order to consolidate their public finances. Each country was given a specific medium-term objective for the budget position, agreed at European level: a position in balance or surplus, depending on its specific sensitivity to the economic cycle and to interest rates; the objective was subject to review in the light of long-term factors such as population ageing and the debt level. In addition, the countries whose public debt exceeded 60 per cent of GDP had to reduce it “at a satisfactory pace”. When the global crisis came, many countries were still far from achieving those objectives. BIS central bankers’ speeches Second, the system of multilateral surveillance did not prevent pronounced macroeconomic imbalances: productivity differentials, current account deficits, excessive private sector borrowing. In 2009, the deficit on the current account of the balance of payments amounted to 10 per cent in Greece and 7.5 per cent in Portugal. In Ireland, Portugal and Spain, the financial debt of households and firms amounted to between one and a half and two times the euro-area average of 170 per cent of GDP (in Italy it was equal to 130 per cent). In Ireland, the largest national banks had balance-sheet assets totalling more than five times GDP; the collapse of property prices and the recession caused them huge losses. Imbalances of this kind ultimately have repercussions on the public finances, even in countries where these are initially in order. In the Irish case, the public resources spent on supporting the banks came to more than 20 per cent of GDP. Last autumn the European Commission and the working group led by European Council President Herman Van Rompuy put forward proposals concerning both aspects: how to make the Stability and Growth Pact more cogent; how to extend surveillance to macroeconomic developments. It was proposed that the Pact be strengthened for the prevention of fiscal imbalances, by intensifying monitoring and introducing timely monetary sanctions, and for their adjustment, by providing in particular for the possibility of initiating the excessive-deficit procedure not only when the deficit exceeds 3 per cent of GDP but also when the reduction in the debt towards the 60 per cent ceiling is deemed unsatisfactory. In the macroeconomic field, a system of monitoring imbalances having potentially significant implications for the euro area’s financial stability was envisaged, with quantitative indicators and critical thresholds based on which the European Council may issue recommendations to the country concerned and, in the most serious cases, apply financial sanctions. Lastly, it was recommended that the EFSF be replaced from 2013 onwards by a permanent mechanism of financial support, the European Stability Mechanism (ESM). Only the countries considered to be solvent would have access to financing, which would be conditional in any case on their adopting serious adjustment plans; the others would be asked to negotiate a debt restructuring plan with private creditors by which to return to a situation of solvency. On 15 March the EU finance ministers agreed a “general approach” that fully implements the recommendations of the Commission and of the Van Rompuy working group. In particular, they approved the proposal to introduce a numerical rule – one twentieth of the debt-to-GDP ratio in excess of the 60 per cent ceiling – for the annual reduction of the debt. Several days earlier the Heads of State and Government of the euro area had increased the effective lending capacity of the EFSF to €440 billion and set that of the future ESM at €500 billion; they also decided that in exceptional circumstances both the Fund and the Mechanism could purchase euro-area countries’ government securities on the primary market. The pact for the euro, with all these measures, widens the focus of attention to include macroeconomic imbalances, strengthens budget discipline in the area, and improves the mechanism of support for countries that get into financial difficulty. This was a necessary step to avoid dangerously sapping the Community spirit that is the lifeblood of the euro. The measures are based on correct principles. The technical and negotiating effort involved has been substantial; the results are encouraging but not yet sufficient. Discussion of the pact will continue in policymaking fora; deficiencies or points that are hazy can be corrected. Fiscal policy surveillance needs to rely on more automatic procedures that limit the politicization of public accounting as far as possible and avert possible collusive conduct between countries. Several other aspects of this complex reform of European governance still require attention and work. It is necessary, for example, to determine with precision all BIS central bankers’ speeches the “relevant factors” to be considered in assessing the adequacy of the pace of public debt reduction; to identify the set of indicators serving to signal a situation of macroeconomic imbalance and the related critical thresholds; and to establish the criteria for evaluating a country’s solvency. Concerning structural policies to boost potential output and competitiveness, the pact, for the time being, relies on procedures based on peer pressure, which in the case of the Lisbon strategy have not worked. The commitment of the national governments remains central. We must not forget a golden rule: increasing the economy’s growth potential and consolidating the public budget are national priorities first of all. Governments should pursue them even independently of the European rules, for the good of their peoples, and should do so with special commitment in the countries farthest from these objectives. Italy’s situation Between 2008 and 2009, with the global crisis in full swing, Italy’s budget deficit rose from 2.7 to 5.4 per cent of GDP; discretionary policies did not contribute to the increase.2 The deficit of the euro area as a whole more than tripled, rising to 6.3 per cent. In 2010 the deficit declined to 4.6 per cent in Italy, while in the euro area it remained unchanged according to European Commission estimates. The Government’s management of the accounts was facilitated by the fact that the solidity of the Italian banking system did not require significant aid to be charged to the public budget. Italy’s public debt, already very high, rose again. Its management was prudent; the average residual maturity was lengthened progressively, notwithstanding a context that remained uncertain and volatile. The financial condition of firms and households is solid on the whole. Savers’ propensity to invest in high-risk financial instruments is low; debt is limited, although it is concentrated in variable-rate liabilities, which are inherently riskier. The Italian economy’s problem – it is well worth recalling – is the structural difficulty of growth. The arduous task of economic policy is to change this situation while at the same time reducing the ratio of public debt to GDP. To rebuild a solid primary surplus rapidly and not to elude the need to take measures that structurally support growth: this is the challenge. Raising the tax rates is out of the question: it would jeopardize the objective of growth and penalize honest taxpayers unbearably; indeed, the rates ought to be gradually lowered as headway is made in reducing tax evasion and avoidance. The only option is to control spending, but with a selective approach that distinguishes between what fosters growth and what impedes it. Wise political choices must necessarily be based on a detailed assessment of the effects, including the macroeconomic effects, of every expenditure item. The more attentive multilateral surveillance of the sustainability of public budgets envisaged by the new pact is not to be feared; it can help us. The reforms already carried out, especially the pension reform, put us among the countries that require a smaller correction of budget balances to ensure long-run stability. The new European rule for debt reduction would not be a much tighter constraint for us than the one already imposed by the existing rule on structural budget balance. It is estimated that See Britta Hamburg, Sandro Momigliano, Bernhard Manzke and Stefano Siviero, “The Reaction of Fiscal Policy to the Crisis in Italy and Germany: Are They Really Polar Cases in the European Context”, forthcoming in Fiscal Policy: Lessons from the Crisis, proceedings of the Twelfth Workshop on Public Finances, Perugia, 25–27 March 2010. BIS central bankers’ speeches achieving structural budget balance would also ensure, ipso facto, compliance with the rule on debt under favourable scenarios of economic growth.3 * * * Seventeen sovereign countries that share a single currency form a reality without precedent in history. The euro is a bold intellectual construction, a courageous and farsighted political project. It was, and remains, a prerequisite for economic wellbeing. The President of the Republic, in his address to Parliament on 17 March, called European integration “an extraordinary historical invention in which Italy has successfully played a leading role since the 1950s.” One hundred and fifty years ago we Italians undertook an equally important construction: our country’s monetary unification, which would then consolidate the political unification just attained. These two historical events are joined in an ideal continuity. For us, the present and the future of the euro are also the continuation of our own long history. See Ignazio Visco, “La governance economica europea: riforma e implicazioni”, Remarks delivered at the University of l’Aquila for the twentieth anniversary of the Economics Faculty, 8 March 2011 (only in Italian). BIS central bankers’ speeches | bank of italy | 2,011 | 3 |
Remarks by Mr Ignazio Visco, Deputy Director General and Member of the Governing Board of the Bank of Italy, at the Brussels Economic Forum 2011, "Rethinking economic policy in Europe - a new era of EU economic governance", Session II: "EU economic governance framework in practice - ensuring its robustness", Brussels, 18 May 2011. | Ignazio Visco: The new EU economic governance and market discipline Remarks by Mr Ignazio Visco, Deputy Director General and Member of the Governing Board of the Bank of Italy, at the Brussels Economic Forum 2011, “Rethinking economic policy in Europe – a new era of EU economic governance”, Session II: “EU economic governance framework in practice – ensuring its robustness”, Brussels, 18 May 2011. * * * The Economic and Monetary Union has been a success in many respects. It has enhanced internal trade and delivered a credible monetary policy that has anchored inflation expectations and fostered a culture of price stability. The euro rapidly attained the status of a strong international currency. However, the functioning of EMU has been hampered by some very serious pitfalls in its institutional design. We now clearly see an asymmetry between the strength of the “monetary” pillar and the weakness of the institutional framework. The architects of EMU understood that fiscal discipline was necessary for the functioning of a monetary union in which the single monetary authority would be confronted by multiple national fiscal policy-makers. To achieve fiscal discipline they relied on a multilateral surveillance mechanism based on fiscal rules. The European sovereign debt crisis has shown that the surveillance mechanism has not been effective. European rules were not sufficient to induce countries to adopt prudent fiscal policies in good times. The result was that many euro area countries faced the crisis with relatively high deficit ratios, still far from their medium term objectives; those objectives, equal to a balanced budget for most member states, would have allowed countries to let automatic stabilizers operate in unfavourable circumstances without exceeding the 3 per cent threshold. In several countries the debt-to-GDP ratio was above the 60 per cent ceiling, in some cases still by a large margin. Fiscal rules and procedures failed on more than one occasion. In 2003 a trade-off of short-term interests within the European Council stopped the rules from being applied to Germany and France. This reflected the lack of an independent enforcer. The sustained fiscal profligacy in Greece was not timely reflected in official fiscal data (the estimate for 2009 deficit, which in April of the same year was 5.1 per cent, was progressively revised upwards to 15 per cent). This case exemplifies problems of the statistical monitoring framework. There is a wide consensus that fiscal rules should be broader (encompassing debt dynamics) and more effective (via new voting procedures). The crisis has also highlighted that low public debts and deficits do not guarantee fiscal sustainability. In a crisis, private liabilities can quickly turn into public debt. Before the crisis, the fiscal performance of Ireland was considered extremely successful. From the launch of EMU, it almost halved its debt-to-GDP ratio, reducing it to 25 per cent in 2007. The recession more than doubled it. Furthermore, households and non-financial firms were highly indebted (their debt burden was about two and a half times GDP); the major Irish banks had balance sheet assets equal to five times GDP. The fall in real estate prices and the recession caused them big credit losses; the political decision to use public funds to bail out reckless financial institutions has pushed up the public debt by more than 20 percentage points of GDP so far, to a level of about 95 per cent of GDP in 2010, with further disbursements anticipated for this year following the results of the stress tests conducted on banks. Perhaps, the crisis would have been less severe if a framework to detect and tackle macroeconomic imbalances and systemic risks had been in place. This has prompted the introduction of a second pillar in EU economic governance: macroeconomic surveillance. But there is a need for a third pillar: market discipline. I will not focus on the temporary arrangements devised to cope with the significant short-run challenges posed by the crisis. Rather, I would like to offer some remarks on the long-term institutional set-up that is currently taking shape in the European Union. During the early stages of the debate on the new European architecture, there was relatively little emphasis on the role that markets can BIS central bankers’ speeches play to induce fiscal discipline. The issue gained prominence in November 2010, when the main characteristics of the European Stability Mechanism (ESM), the permanent mechanism slated to replace the European Financial Stability Facility (EFSF) in June 2013, were spelled out. Scepticism on the effectiveness of market-based fiscal discipline was already present in the early stages of the EMU project. The final report of the Delors Committee remarked in 1989 that: “the constraints imposed by market forces might either be too slow and weak or too sudden and disruptive”. The European Commission expressed similar concerns a year later. And many years earlier, Luigi Einaudi, the great Italian economist and statesman, summed up the common view by saying “i risparmiatori hanno cuore di coniglio, gambe di lepre…” (“investors have the heart of a rabbit, the legs of a hare …”). I think it is fair to say that the mistrust in market discipline finds support in the EMU experience. In the period from 1999 to mid-2007 (just prior to the sub-prime crisis) markets almost did not differentiate among European sovereigns. Sovereign yield spreads relative to the German 10-year benchmark ranged from 5 basis points for Ireland to 50 basis points for Greece. The interest rate differentials for Greece, Ireland and Portugal were still below 50 basis points in the spring of 2008. After a period of increased financial market tension, during which, however, the spread on Greek and Irish bonds rarely exceeded 300 basis points, at the beginning of December 2009 10-year spreads were back below 200 basis points for all three countries. After that they spiralled upwards, reaching 660, 380 and 330 basis points, respectively, between the end of April and the beginning of May 2010. There were several more acute bouts of tension on the euro area sovereign debt market in the second half of 2010 and the first few months of 2011. The pressure eased temporarily after the decision, last March, to increase the lending capacity of EFSF and to establish a permanent crisis resolution mechanism. But, also reflecting the perception that in the transition from the EFSF to the ESM the burden on private creditors may become extremely heavy, spreads have risen again to very high levels and now stand above 650 basis points for Portugal, 750 for Ireland and 1250 for Greece. Formal statistical exercises also find a relatively weak correlation between spreads and fiscal fundamentals (i.e. the debt level, present and projected primary deficits) in the pre-crisis period. The correlation became stronger later, when it was already too late to avoid a major area-wide turmoil. The issue, then, is how markets can exercise a more prominent role, working properly – which means gradually – to complement rule-based fiscal surveillance. A deterioration of the cost and availability of funds to both private and sovereign issuers provides a strong incentive to correct irresponsible behaviour, tracking closely both the country’s fiscal fundamentals and private sector’s weaknesses (that may prompt the government to step in). Thus, the key question is when and under what conditions credit markets provide sufficient incentives to restrain irresponsible borrowing. The recent experience suggests that investors will be more effective in disciplining euro area governments if certain institutional prerequisites are met. First, borrowers must adequately and promptly respond to market signals. Second, transparent and timely information concerning the actions and the budgetary position of sovereign lenders should be available to all agents (and a reform designed to improve the quality and reliability of fiscal statistics by strengthening Eurostat’s powers has been recently adopted). Third, full bail-out of troubled governments should be credibly ruled out. A no-bail-out clause is already enshrined in the European treaties, but many investors were inclined to believe that the clause would not be applied in an emergency. This implied that, ex ante, investors did not demand sufficiently higher premia for holding government bonds with higher default risk. By contrast, if the threat of a default is credible, this will foster stricter market oversight and induce less fiscal profligacy ex ante. In equilibrium, default will be less, not more, likely. But how can a no-bail-out clause be made credible? The answer, of course, is by making, ex post, the bail-out more costly than a bail-in for official lenders; that is, by reducing the spillover of a sovereign default so that the economic and political costs of a default fall mainly on the defaulting country. It is paramount to weaken the link between sovereign risk and bank BIS central bankers’ speeches risk. This will require a careful analysis of the many different channels through which a deterioration in fiscal conditions affects the cost and availability of bank funding. For example, regulators might want to carefully assess the (regulatory) incentives banks have to hold excessive amounts of risky sovereign bonds, and the collateral rules that are used by central banks and in wholesale markets could be reconsidered. The link between sovereign and bank credit ratings should also be carefully examined. Rules and markets should not be seen as mutually exclusive, but as mechanisms that complement and reinforce each other. The challenge would be not only to limit the intermediary’s exposure to a given sovereign borrower considered in isolation, but also to guarantee that intermediaries can survive even if debt restructuring in one country triggers restructuring in others. It should also be taken into account that a default can threaten financial stability through its impact on derivative markets (e.g. the market for credit default swaps). All this clearly requires regular stress testing of financial intermediaries and the availability of timely and objective assessments of sovereign risk. Such assessments should evaluate fiscal conditions and prospects, consider the level and trend of private sector indebtedness, and take a country’s prospects of growth into account. Clearly, this is a formidable challenge, and we know too well that it has not been satisfactorily addressed by credit rating agencies. But we have to find ways for such institutions to develop proper standards and operate in a transparent relationship with national agencies such as independent national fiscal councils, supranational (in Europe, Community) institutions and international financial organisations. Ex-ante procedures that facilitate an orderly default should be considered. The European Council’s proposal to introduce collective-action clauses (CACs) would help to make debt restructuring more likely and quicker, credibly reinforcing the threat of a default. If approved, however, the innovation will apply only to new debt issues, potentially raising a problem of market segmentation and indirectly providing a senior status to current bonds. As Axel Weber and his Bundesbank colleagues have recently suggested, a clause that automatically extends debt maturity when a country gets the ESM assistance could also be included. This would put some of the burden of restructuring on short-term borrowers, who otherwise would benefit disproportionately from ESM intervention. It would make private sector involvement possible as soon as the crisis manifests itself, whereas CACs can only play a role in the later phases of a crisis, when ESM help has already proven ineffective. The introduction of the ESM rightly envisages the involvement of the private sector in all cases where the sovereign borrower is deemed insolvent (short-term illiquidity problems are instead properly addressed with ad hoc and conditional financial help). Of course, the devil is in the details. There is no foolproof way to distinguish short-term illiquidity from fundamental insolvency (the quest for a clear-cut answer probably started with Bagehot around 1870). So the ESM (like any other lender of last resort) is exposed to two kinds of risk: bailing out an insolvent borrower and allowing the bankruptcy of an illiquid one. Furthermore, unlike private borrowers, sovereigns usually can choose whether or not to honour their debts, so that the issue is not really insolvency in the strict sense (i.e. inability to repay) as unwillingness to repay owing to exceedingly high social or political costs, which are even less straightforward to judge and to measure. Still, this issue cannot be avoided. We need to think about what institution should be in charge of such evaluations, and acknowledge that it should comprehensively consider the evidence and assessments provided by credit rating agencies, national fiscal councils, international financial institutions and organizations. A tough assignment, indeed. To conclude, I have to confess that, in a sense, I have cheated you. My Einaudi’s quotation was actually incomplete. He not only said that “investors have the heart of a rabbit, the legs of a hare…”; he continued and said that they have “…la memoria di un elefante” (“the memory of an elephant”). This should be a reminder of the disruptive consequences of a default, which often permanently stains a government’s reputation. Governments that default are excluded for potentially long periods from international capital markets, especially when BIS central bankers’ speeches markets consider the default opportunistic. They also face an increased cost of borrowing thereafter. Finally, and perhaps most importantly, default also signals an overall lack of reliability of the country. A proper design of the conditions for the ex-ante involvement of creditors in an orderly restructuring of the debt of a sovereign borrower and the definition of appropriate incentives for a more gradual, timely and responsible market assessment would significantly reduce the probability of sovereign default and the risk of extremely harmful financial stress associated with such an event. BIS central bankers’ speeches | bank of italy | 2,011 | 5 |
Address by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the inauguration of the exhibition "The currency of united Italy: from lira to euro", Palazzo delle Esposizioni, Rome, 4 April 2011. | Mario Draghi: The culture of monetary stability from unification to the present day Address by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the inauguration of the exhibition “The currency of united Italy: from lira to euro”, Palazzo delle Esposizioni, Rome, 4 April 2011. * * * The Bank of Italy is making a twofold contribution to the 150th anniversary of the Unification of Italy. With the collaboration of numerous experts from Italy and abroad, it is sponsoring a vast research project – entitled Italy and the World Economy, 1861–2011 – on the Italian economy’s response to the major changes in the international scenario that have taken place from the birth of the unified State to the present day. The results of this research will be presented at a conference in Rome on 13, 14 and 15 October. For the wider public, and particularly for young people, we are inaugurating today the exhibition on The currency of united Italy: from lira to euro. The thread that runs through the 150 years of Italian monetary history since unification draws together two fundamental events: the country’s monetary unification, which the newly formed Italy undertook in order to strengthen the foundations of its political unity; and, closer to our time, Italy’s participation in European monetary unification, achieved despite the lack of political unity. This story, from the lira to the euro, illustrates a central point for all of us today – the importance of monetary stability and of a political and economic culture that recognizes its value. Guido Carli suggested a logical path to take. “If international competition”, he wrote in 1961, “is indeed the most powerful incentive towards our country’s economic development, there can be no doubt that, in turn, its strongest pillar is monetary stability. This, too, is a lesson handed down to us through a century of Italy’s – sometimes painful – experiences as a nation state.”1 The concept of monetary stability changes with time, alongside the technological and institutional conditions that determine it. Between the 19th and 20th centuries, Italy, too, switched from a system in which money was made of, or could be converted into, precious metal to one based on purely fiat money. In the first system, monetary stability is ensured by maintaining the gold convertibility of the currency at a fixed parity. By and large, Italy managed to do this: on the eve of the First World War, despite some periods of inconvertibility, the price index was at the same level as in 1861. This stability was regarded as the natural state of things. With the ascendancy of paper money, a radical institutional overhaul took place in the monetary field. The modern central bank came into being, and standards, rules and organizations were established to manage a currency whose value was no longer anchored to that of a metal, but instead based entirely on trust. As early as 1839 Carlo Cattaneo warned, in his review Il Politecnico, that “paper money must not be issued except on behalf of the State, and that, with all the rigorousness and all the Banca d’Italia (1961), Abridged version of the Report for the year 1960, “Concluding Remarks”, 111. BIS central bankers’ speeches solemnity of laws and fundamental orders, its quantity must be made proportionate to needs, that is, to the volume of transactions.”2 It was not until 1893 that the Bank of Italy was founded, with the main task of centralizing the function of note issuance, which until then had been distributed among six local banks. It immediately took on the broad role of guarantor of monetary stability and centre of the financial system. In the words of Marco Fanno, it becomes “the central institution around which the banking structure gravitates and on which it is hinged, …the body regulating the market, … the last line of defence to activate at times of grave difficulty.”3 The suspension of the gold convertibility of banknotes during the First World War drew the attention of economists and economic policy makers directly to inflation, not in the old sense of increase in the stock of banknotes but in the modern sense of rise in the general price level. The value of money lies in its purchasing power and therefore inflation means devaluation of the currency. Keeping prices down – although still instrumental to the lira’s external convertibility – became the objective of economic policy under the new system of the gold exchange standard that prevailed after the War. Right after the Second World War the lira fell to a thirtieth of its pre-war value as a result of a flare-up of inflation, extinguished by the monetary stabilization engineered by Einaudi and Menichella. Einaudi called for a concerted effort to avert “monetary unity’s destruction”.4 The laborious task of rebuilding confidence in the currency, and thus of reconstituting savings, was pursued with courageous determination, in the belief that the defence of the currency would create a solid basis for the country’s economic recovery. The path of international integration was followed by joining the Bretton Woods monetary system. In the 1950s Italy enjoyed a period of unprecedented monetary stability and economic growth. The exchange rate with the dollar was stable, and remained so until 1971; for the first time the rate of inflation in Italy was in line with, if not lower than, that of the other leading European countries. The end of the Bretton Woods system at the beginning of the 1970s concluded the transition from commodity money to fiat money. Troubled times ensued: international economic relations were affected by deep shocks, such as the oil crises. During this passage Italy paid a high price in terms of loss of value of the lira: double-figure inflation eroded households’ purchasing power and periodical devaluations gave only temporary relief to a productive system labouring to restore its efficiency and competitiveness. In the following decade the decision was taken to advance the construction of the European Community through the completion of the single market and, eventually, the Economic and Monetary Union and the euro. Italy took a leading role, responding to the widespread aspiration of the nation. These prophetic words were pronounced by Carli at the beginning of the 1970s: “During Italy’s Risorgimento the European ideal was deeply engrained in the effort to achieve national unity, so that the two ideals were not seen as contradictory but as phases of a single process moving towards the expression of a culturally homogeneous community. Events in the last decades have given a sense of urgency to what might have seemed a utopian vision during the last century, so that the accomplishment of European unification is considered an indispensable development for the very survival of the values embodied in national ideals.”5 Carlo Cattaneo (1839), “Delle crisi finanziarie e della riforma del sistema monetario”, Il Politecnico, 1, June, 548. Marco Fanno (1912), Le Banche e il Mercato Monetario, Athenaeum, Roma, 131 and 147. Banca d’Italia (1947), Annual Report of the Governor to the General Meeting of Shareholders, “Final Considerations”, 51. Bank of Italy (1973), Abridged version of the Report for the year 1972, “Concluding Remarks”, 222. BIS central bankers’ speeches Today, there is reason to believe that the stability of the currency and of prices depends on the expectations of economic agents. These expectations are formed on the basis of such elements as the clarity and certainty of the rules of money creation and the reliability and credibility of the institutions managing it. The establishment of a culture of monetary stability is crucial for this to become a virtuous circle. Luigi Einaudi believed that money was a contract between economic agents and that its stability had to be built by educating them. As a young economist, in 1905 he undertook the translation into Italian of Walter Bagehot’s Lombard Street,6 the classic Anglo-Saxon text on monetary stability, certain that it would be effective also in forming public opinion. As Governor he invented the medium of the Concluding Remarks to speak to the Italians, not just to the experts. Faced with the pernicious inflation route, in 1947 he claimed it was the right and the duty of the senior management of the Bank of Italy to issue “a cry of warning”, while at the same time loudly avowing that “it is a road we shall not take.”7 In the last half century the Bank of Italy has indeed maintained this commitment to educate and inform with the publication of research papers by the Economic Research Department, public talks by senior management, and not infrequent contacts with universities and with the new generations. Tommaso Padoa-Schioppa explained, sixteen years ago, that a central bank contributes to monetary stability also through “a constant effort of information, education, and clarification that is part and parcel of defending the value of the currency.”8 Nowadays, the central banks know that effective communication and widespread understanding of monetary matters are essential for the success of their monetary policy strategy. The Eurosystem is committed to informing the markets and the public about how it thinks, decides and acts. This is also a way of keeping price expectations stable over the medium-to-long term. Now that monetary stability no longer hinges on the amount of precious metal available in the system, it relies on the credibility and technical expertise of the central banks. But the latter are powerless if the value of stability is not firmly ingrained in the collective consciousness. The objective of the exhibition we inaugurate today, and of the permanent museum that will later take its place, is to help entrench this value, which is a common, founding legacy of European citizenship. Walter Bagehot (1905), Lombard Street – Il mercato monetario inglese (translation by Prof. L. Einaudi), Utet, Turin. Bank of Italy (1947), Relazione Annuale, “Considerazioni Finali”, 255. Tommaso Padoa-Schioppa (1995), “La sicurezza monetaria e le banche centrali”, talk given at the Centro Alti Studi Difesa in Rome on 9 June 1995, published in the series Banca d’Italia – Documenti, 489, 9. BIS central bankers’ speeches | bank of italy | 2,011 | 5 |
Concluding remarks by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the Ordinary Meeting of Shareholders 2010 - 117th Financial Year, Bank of Italy, Rome, 31 May 2011. | Mario Draghi: Overview of economic and financial developments in Italy Concluding remarks by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the Ordinary Meeting of Shareholders 2010 – 117th Financial Year, Bank of Italy, Rome, 31 May 2011. * * * Ladies and Gentlemen, When I first took the floor before this annual meeting on 31 May 2006, I said that I felt that one of my duties was to lead the Bank of Italy towards change, in all its vast field of action, “contributing substantively to the formulation and implementation of monetary policy in the euro area; expanding and strengthening banking supervision while adapting it to the new international rules; making the Bank once again the trusted, independent advisor to Parliament, the Government and the general public”. The Bank responded. It answered the call thanks to its wealth of skills; thanks to its independence. In these last five years we have changed the structure, organization and work procedures of the Bank. The number of branches has passed from 97 to 58. We now have a more efficient network, better able to respond to the needs of the local communities. The Italian Foreign Exchange Office (UIC) has been closed. The Financial Intelligence Unit has been instituted with the task of preventing and combating money laundering and the financing of international terrorism. The Bank of Italy and UIC together employed almost 8,500 people in 2005; the number now stands at just over 7,000. The path of change will be pursued with determination, with a spirit of innovation. We are counting on everyone’s active collaboration. The Bank’s staff is its greatest asset. We are continuing to refine our recruitment procedures and focusing on professional development, well aware that our institution’s future rests on the knowledge and skills of the men and women who work here. On 18 December Tommaso Padoa-Schioppa passed away, all too soon. He joined the Bank of Italy in 1968 and left almost thirty years later as Deputy Director General to serve successively as Chairman of Consob, member of the Executive Board of the European Central Bank and Minister for the Economy and Finance. His death deprives our country of his gifts of intelligence and passionate civic commitment. We will be holding a conference in his memory here in December, a year after his decease. The Bank of Italy has been a precious source of dedicated public servants for Italy and Europe. Merit and independence: these are the essential conditions for the credibility of its analyses and for the effectiveness of its action. These are values to be preserved if the country is to continue to benefit from an authoritative voice with no vested interests. These have been the guiding principles of my mandate. The world after the crisis The economic policy response to the 2008–09 crisis was rapid, effective and coordinated internationally. Support from budgetary policies and the injection of liquidity to sustain the markets were unprecedented. The collapse of the international financial system was averted. There are some lessons to be drawn from this crisis: the social safety net, which held, is BIS central bankers’ speeches essential; bank failures must be managed; international cooperation, indispensable during the emergency, remains so when reconstructing the system. In 2010 the global economy returned to growth at a rate of almost 5 per cent. In the emerging countries huge numbers of people are leaving poverty behind, even though this process is being held back by rising food prices. Overall the financial system is gradually recovering. But the legacy of the recession is a heavy one. The most advanced economies, with the exception of Germany, are struggling to return to the previous rates of growth; the recovery is still too weak to reduce unemployment. In the emerging countries, with growth rates close to 10 per cent in some cases, signs of inflation are beginning to appear; in several of these countries inflows of capital have reached the high levels prevailing before the crisis. The economic policies energetically applied in the advanced countries to counter the worst effects of the crisis have reached their limits. The public debt of these countries, equal to 73 per cent of GDP in 2007, will exceed 100 per cent this year. The risk premiums on public debt are growing everywhere, dramatically so in the economies where the public finances have deteriorated the most. In the euro area, the sovereign debt crisis of three countries – which together account for 6 per cent of the area’s GDP – can potentially have significant systemic effects. Public finances must be brought under control. A prolonged expansionary policy undermines the sustainability of the debt and damages economic growth. In Europe a start has been made on adjustment. This could not be postponed, despite the weakness of the recovery. The emerging economies’ prompt return to growth, adverse climatic events and socio-political upheaval in the Mediterranean and Middle East have pushed up the prices of energy sources and food, by more than 30 per cent in the last six months. The risk of inflation is rising. There is now a greater need to proceed with monetary policy normalization so as to prevent expectations of higher inflation from becoming entrenched. External current account imbalances between large debtor and creditor countries, one of the factors underlying the crisis, have begun to increase again. Differences in the propensity to save and in the composition of domestic demand are the main causes, together with rigid exchange-rate policies. Today the Group of Twenty is committed to a global economic policy promoting strong, sustainable and balanced growth. However, the imbalances in international payments are set to last and they must be funded. It is therefore crucial that the financial system is solid. The reform of the rules remains a priority on the international agenda. It must be completed. The reform of finance Important steps have already been taken. Thanks to unprecedented international cooperation, the measures adopted will make the financial system much more resilient. All the leading countries have revised their systems of regulation and supervision in three directions: to reduce the risks for stability, increase cooperation among authorities, and broaden the scope of the rules. Basel III has established higher requirements for banks’ capital and raised its quality. It has placed restrictions on financial leverage and introduced new liquidity rules. We have eliminated many of the perverse incentives that encouraged the assumption of excessive risks in securitizations, by revising the role of rating agencies and reviewing accounting standards and prudential rules. Transparency and the reduction of systemic risk are guiding the reform of over-the-counter derivatives: the standardization of contracts, centralized clearing, more demanding capital BIS central bankers’ speeches requirements, and the obligation to provide information to trade repositories are the pillars of the new system. The reform has not yet been completed, however: it is necessary to tackle and reduce the moral hazard associated with systemically important financial institutions; it is necessary to increase the transparency and reduce the risks generated by the shadow banking system, a grey area between the regulated and the unregulated sectors. Either because they received public support at the height of the crisis to prevent failures with devastating consequences or because governments provided them with more or less explicit guarantees, it is widely believed that the largest banks cannot fail. This leads to serious competitive distortions but above all to the unacceptable idea that profits are private and losses public. Systemically important financial institutions must be allowed to fail if necessary, in an orderly manner, while preserving the essential banking and payment system functions and with the costs of their collapse not borne by the taxpayers but by the shareholders and certain categories of creditors. Beginning with those of a global size and nature, they will also have to be able to absorb larger losses. Common equity remains essential to the achievement of this objective. The supervision of these institutions will have to be enhanced, made commensurate with the risks they can create. In many countries this will require a significant increase in the authorities’ powers and independence. The Financial Stability Board will present detailed recommendations at the G20 summit in November. Before the crisis, much of the financial leverage and liquidity risk originated within the shadow banking system. The first objective of the Financial Stability Board is to establish the capacity to assess the risks in this sector adequately. Rules will then be introduced for the activities of the shadow banking system that can generate systemic risks. In tracing the new perimeter of regulation, the FSB will concentrate on those currently unregulated bodies that engage in credit intermediation with maturity transformation that are currently unregulated and are therefore subject to liquidity risks. The extension of the perimeter should follow the principle that similar activities and risks must be subject to the same rules. It is now essential to ensure the complete implementation of the new rules, as scheduled and in all the different jurisdictions. The United States and Europe have a key responsibility. National interests must not prevail, otherwise the credibility of the reform and financial stability itself will be undermined. Intermediaries cannot call for shared rules to ensure a level playing field and at the same time seek competitive advantages through their less strict application at national level. The euro and Europe The euro-area budget deficit should be about 4.5 per cent of GDP this year, less than half those of the United States and Japan; at 88 per cent the public debt is lower than that of the United States and far below the Japanese level; the external current account is nearly in balance. The economic recovery is gathering strength, with GDP growth not far from 2 per cent expected this year. The Economic and Monetary Union is nonetheless faced with the most difficult test since its creation. In three years the public debts of Ireland, Greece and Portugal have grown in relation to GDP by 71, 37 and 25 percentage points respectively. The European surveillance of national budgetary policies revealed itself to be inadequate; it had been weakened at the initiative of the three largest countries in the middle of the last BIS central bankers’ speeches decade, precisely when it became essential. A simple accounting exercise shows that if the rules of the Stability and Growth Pact had always been obeyed, on the eve of the crisis the ratio of public debt to GDP would have been over 10 percentage points lower in the euro area and 30 points lower in Greece. Even assuming that the worsening of budget deficits during the crisis was inevitable, at the end of last year no country’s debt would have been more than 100 per cent of GDP. For a long time the single currency concealed the differences between member countries’ underlying conditions and economic policies and the absence of really binding common rules. For a long time risk premiums did not reveal the truth. The global crisis has accentuated the perception of risk by some investors and disclosed weaknesses in the architecture of the Union. The yield spreads on member countries’ securities have widened; the process was sometimes so sudden that some market segments risked paralysis. National governments and European authorities responded to the emergency with exceptional measures, so as to limit the risk of contagion and safeguard the area’s financial stability. In cooperation with the International Monetary Fund, loans were granted, conditional on rigorous adjustment plans that the countries in difficulty have undertaken to comply with. There are no shortcuts available. The response to the debt crisis is first and foremost in national policies, in the complete implementation of the adjustment plans that have been agreed. Solidarity among the member countries of the Union must be matched by a sense of responsibility and compliance with the rules. The financial support of euro-area governments allows countries to proceed with adjustments sheltered from market volatility. It is not a fiscal transfer between countries and is subject to stringent conditions. The return to financial health is possible. In the last few months I have frequently recalled Italy’s experience at the beginning of the 1990s, when the country was faced with a major crisis of confidence in the sustainability of the public debt. Every year, we had to place securities on the market worth, in real terms, ten times Greece’s current annual borrowing requirement and twice its value in relation to GDP. Italy overcame this crisis without any assistance from abroad, thanks to an ambitious budgetary consolidation plan, important structural reforms, and a programme of privatizations amounting to around 10 per cent of GDP. Beyond the emergency, some important steps have already been taken to tackle the known but long neglected underlying weaknesses of the European architecture. The proposals of the EU Commission and Council reinforce surveillance over budgetary policies. They can be made more ambitious by making procedures more automatic so as to shield them from the arbitrary nature of political negotiations. The European Parliament can have an important influence in this regard. As was hoped, rules similar to those governing national budgets will be extended to the surveillance of situations of macroeconomic imbalance, with special consideration for the state of member countries’ external accounts. A commitment to reinforce the competitiveness and convergence of the national economies has been undertaken with the Euro Plus Pact, which nevertheless needs to be made more binding. The new European supervisory authorities began operating at the start of the year. The European Systemic Risk Board (ESRB) is laying the foundations of the system to prevent and, where necessary, manage situations that are critical for financial stability. The European Banking Authority (EBA) will consolidate supervisory rules and practices, which are currently fragmented at national level. BIS central bankers’ speeches Monetary policy The Eurosystem has played a crucial role in countering the effects of the crisis. The credibility it has gained over the years has enabled it to keep inflation expectations steady and to act with the speed and flexibility demanded by extraordinary circumstances. Thanks to measures designed to ensure the supply of liquidity to the markets, the European Central Bank has avoided the collapse of the financial system. It has rapidly reduced the policy rate to 1 per cent, the lowest level ever reached by official rates in the euro-area countries. Since the end of last year, the large rises in raw material prices have pushed the inflation rate to over 2 per cent. The ECB Governing Council has re-asserted its determination to prevent international price trends from provoking, apart from the inevitable short-term effects, a deterioration in inflation expectations. At its meeting in early April the Council raised official rates by 25 basis points. Even with this measure, monetary conditions remain accommodating. The grave repercussions of the sovereign debt crisis for the functioning of the financial sector have necessitated exceptional measures, as at the height of the financial crisis in 2008 and 2009. Extraordinary measures to refinance the banking system that had been discontinued earlier have been revived; a programme of purchases of sovereign debt securities issued in the euro area (the Securities Market Programme) has been launched. These measures are by nature temporary and designed to safeguard the mechanism by which monetary policy impulses are transmitted to the economy; in the case of the SMP, moreover, they are for a limited amount and the effects on the monetary base are fully sterilized. The ECB has the task of ensuring price stability in the medium term; monetary stability represents its fundamental contribution to growth. Future monetary policy decisions will always be guided by this primary objective. Neither the existence of sovereign risks nor some banks’ abnormal dependence on ECB financing can divert it from this objective. It falls to the national governments to speed up the consolidation of their public finances and implement structural reforms that will raise the potential growth rate of their economies. It falls to the financial intermediaries to continue resolutely towards restoring healthy balance sheets and strengthening their capital base. The Italian economy Italy’s budget deficit, which this year is close to 4 per cent of GDP, is smaller than the euro-area average. According to official forecasts it will be brought below 3 per cent in 2012. The debt, however, is approaching 120 per cent of GDP. The objective of achieving budget balance in 2014 is appropriate, as is the plan to bring the definition of the budget adjustment package for 2013–14 forward to this June. Thanks to the social security reforms introduced in the middle of the 1990s, to a banking system that has not needed government bail-outs, and to prudent management of expenditure during the crisis, the effort we are required to make is less than for many other advanced countries. Without sacrificing capital expenditure more than the current planning scenario already envisages and without increasing revenue, primary current expenditure must be further reduced, by more than 5 per cent in real terms in the period 2012–14, returning to the same level, in relation to GDP, as at the beginning of the last decade. BIS central bankers’ speeches It would be inadvisable to seek a permanent and credible reduction of expenditure by cutting items uniformly across the board: this would make it impossible to allocate resources where they are most needed; it would be difficult to sustain over the medium term; it would penalize the more virtuous government departments. A budget of this kind would weigh on the already weak economic recovery, subtracting about 2 percentage points of GDP over the three years. What is needed, instead, is a skilfully designed package, based on a thorough analysis, item by item, of the accounts of the public-sector agencies, allocating funds according to today’s objectives regardless of past expenditure; refining the indicators of efficiency for the various public service centres (offices, schools, hospitals, courts) so as to introduce widespread improvements in the organization and functioning of the units; maintaining the drive to make the public administration more efficient; and channelling a part of the resulting savings towards investment in infrastructure. Substantial reductions should be made in the high rates of taxation of labour and corporate income, offsetting the loss of revenue by making further progress against tax evasion, beyond the truly appreciable amounts the authorities have recently recovered. Timely, structural budget measures that are credible in the eyes of international investors and designed to foster growth could, among other things by significantly reducing the risk premiums weighing on Italian interest rates, greatly limit the adverse effects on the economy. Fiscal federalism can help by making all levels of government accountable, imposing strict budget constraints and involving citizens more closely in public affairs. There are two essential conditions for this: offsetting the new local taxes with cuts in central government taxes, not summing them; and providing for strict monitoring to ensure legal conduct on the part of the bodies accountable, under decentralization, for spending. Growth Since the start of the recovery, two summers ago, the Italian economy has recouped only 2 of the 7 percentage points of output lost in the recession. In the first quarter of this year its growth rate was barely positive. In the course of the past ten years, Italy’s gross domestic product has increased by less than 3 per cent; that of France, with about the same population, by 12 per cent. The gap perfectly reflects the difference in hourly productivity – stationary in Italy, up by 9 per cent in France. Italy’s disappointing result applies to the country as a whole, North and South alike. If productivity stagnates, our economy cannot grow. The productive economy loses competitiveness; widening deficits appear in the current account of the balance of payments. Foreign direct investment dries up. In the course of a decade, Italy received foreign direct investment inflows equal to 11 per cent of GDP, compared with 27 per cent in France. Wage growth is modest in Italy, as it cannot diverge too sharply from productivity growth: this has repercussions on domestic demand. The real earnings of employees in Italy have been virtually stationary over the past decade, compared with a gain of 9 per cent in France; real household consumption, which has risen by 18 per cent in France, has grown by less than 5 per cent in Italy and only by eroding the propensity to save. Productivity in Italy is stagnating because the system has not yet adapted sufficiently to the new technologies, or to globalization. Understanding the reasons for this has been the aim of much of the research conducted by the Bank of Italy in recent years. I have reported on it several times, most notably in these annual remarks. Our analyses point the finger at Italy’s productive structure, which is more fragmented and static than in other economies; and at government policies that fail to encourage, and often hamper, its development. BIS central bankers’ speeches The problem of the inefficiency of civil justice has to be tackled at the root. Ordinary lower court cases are now estimated to last more than 1,000 days, putting Italy in 157th place out of the 183 countries covered in the World Bank’s rankings. The consequent uncertainty is a major factor of friction in the economy as well as the source of injustice. According to our estimates, the shortcomings of the civil justice system in Italy could subtract up to one percentage point a year from GDP growth. We must proceed with the reform of the education system, on which a start has been made, in order to raise our levels of academic achievement, which are among the lowest in the Western world even with equal expenditure per student. The disparities within Italy remain unacceptably wide, between North and South and between different schools within the same area, even at the level of compulsory education. At the university level, more competition between institutions is desirable in order to establish centres of excellence that can compete in the world arena. The number of university graduates is still low by international standards. According to OECD estimates, the gap between the Italian education system and global best practices could depress the rate of GDP growth by as much as one percentage point in the long run. Competition, which is well rooted in a good part of industry, is making very slow headway in services, especially public utilities. What is wanted is not unrestrained privatization but a system of regulated competition in which the customer, the citizen, is better protected. The challenge of growth cannot be left solely to the enterprises and workers that are directly exposed to international competition, while positional rents and monopoly advantages in other sectors depress employment and undermine the country’s overall competitiveness. Italy lags behind the other main European countries in its endowment of infrastructure, despite having had a higher ratio of public infrastructural spending to GDP from the 1980s until 2008. Under the Government’s programmes the ratio is set to fall to 1.6 per cent in 2012, down from 2.5 per cent in 2009; on average in the euro area, the planned expenditure for 2012 is 2.2 per cent of GDP, down from 2.8 per cent in 2009. Uncertainty in planning, deficiencies in project evaluation and public works selection, fragmentation and overlapping of powers, and inadequate rules on contract awards and project controls result in public works that are less useful and more costly than elsewhere. The execution time for projects financed by the European Regional Development Fund is nearly twice as long as scheduled in Italy, compared with average overruns of just one quarter in the rest of Europe, and cost overruns are 40 per cent as against 20 per cent. In high-speed rail projects and for motorways, the average cost per kilometre and the realization time are greater than in France and Spain to an extent only partially justified by the different topographical conditions. It is essential to restore efficiency in expenditure, in order among other things to make the most of project financing and Community resources, which do not burden the Italian public finances. To date, only about 60 per cent of the motorway network enlargements provided for in the 1997 agreement between the National Road Agency and the main motorway concessionary have been completed, and under 30 per cent of those decided in 2004, while the latest plan, that of 2008, is still under study. The works to be realized are worth €15 billion. Only 15 per cent of the Community structural funds at our disposal has been spent; the unspent portion amounts to €23 billion, to be associated with the required national cofinancing. Speeding these projects up would have a considerable impact on economic activity. The spread of part-time and fixed-term employment contracts in the past fifteen years has helped to raise the employment rate, but at the cost of creating a pronounced dualism within the labour market: on the one hand the better-protected workers with permanent jobs and on the other a vast area of precarious employment, especially among young people, with little protection and low earnings. A more balanced approach to labour market flexibility, which today depends almost entirely on entry mode, would let young people set their sights higher. BIS central bankers’ speeches It would spur firms to invest more in the training of human resources, to integrate them into the production process and to offer them better career prospects. The industrial relations system must foster the modernization and competitiveness of the productive economy, in the interests of both sides. Steps have been taken to strengthen the role of company-level bargaining, but the predominance of industry-wide bargaining and the lack of definite rules governing trade union representation still limit the possibility of workers’ entering into commitments vis-à-vis their firms and weaken their ability to affect their own wages and job security. Women’s low labour market participation is a crucial weakness of the Italian economy, and one on which we are now concentrating our research effort. Today, 60 per cent of Italy’s university graduates are women. They earn their degrees faster and with a better academic performance than their male fellow-students; and they are less and less restricted to the traditional women’s disciplines in the humanities. Yet the employment rate for women is still no more than 46 per cent, 20 points less than for men. It is lower than in practically every other European country, especially in the higher positions and among women with children. Holding education and experience constant, women’s earnings are 10 per cent lower than men’s. Women still devote a great deal more time to home and family in Italy than in other countries. Greater availability of services would help, as would the organization of work to facilitate the reconciliation of family and job commitments and an attenuation of the implicit tax disincentives for women’s work. The social safety net must guarantee adequate income support to anyone who loses a job and is actively seeking another. The fate of those working for firms that can no longer survive in the marketplace must be made less dramatic, in order not to impede the natural turnover of enterprises. Enterprise and finance Italy’s entrepreneurs and workers have the skills and the energy to lift the pace of growth. In spite of crisis and recession, our business surveys of recent years have revealed great vitality in many enterprises. But those skills and those energies are fragmented. Italian firms, on average, are 40 per cent smaller than their euro-area counterparts. The top 50 European corporations by sales include 15 German and 11 French but just 4 Italian firms. Italy’s industrial structure seems static; rarely do firms grow and move up to the next size class. In the early 1960s, plants with over 100 workers employed 43 per cent of Italy’s manufacturing workers, as against over 60 per cent in France and Germany. Since then the employment share of large plants has declined much more sharply in Italy than in France or Germany, to under 30 per cent. The flexibility typical of small firms, which in the past helped to sustain Italian competitiveness, is no longer enough today. We need more medium-sized and large firms that can move rapidly and effectively into international markets and exploit the efficiency gains offered by technological innovation. When one of our firms has a chance to expand, it may be deterred not only by a fiscal, regulatory and administrative framework still perceived as uncertain and costly but also by corporate structures that are often kept impermeable to outsiders. Widespread family control of businesses is not a specifically Italian phenomenon; what is, is the restriction of management to the family circle. Sixty per cent of all Italian manufacturing firms with ten or more workers are exclusively family controlled and managed, compared with BIS central bankers’ speeches under 30 per cent in Germany and France. These firms have less propensity to innovate, engage less in research and development, and rarely penetrate emerging markets. The average Italian firm has less equity capital than its counterparts in the other advanced countries. There is little diversification of sources of funding – consisting largely in bank credit – and the incidence of short-term debt is high. To encourage recourse to equity capital, as part of a comprehensive redistribution of public revenue and expenditure the taxation of the share of profit corresponding to the remuneration of equity should be reduced. Including the regional tax on productive activity, the statutory tax rate on company income in Italy is nearly six percentage points above the euro-area average. Banks and banking supervision Banks have stepped up their lending to firms markedly, in response to the recovery in demand for working capital: the increase amounted to 5.2 per cent on an annualized basis in the three months ended in April; the rate of growth in the twelve months to April was 4.4 per cent, the highest among the main countries of the euro area. The ratio of new bad debts to outstanding loans remained high in 2010, at 1.9 per cent, though far below the figure recorded after the recession of the early 1990s. The data for the first few months of this year signal improvement. Many intermediaries have supported customers by granting debt restructurings or loan repayment moratoria. Such measures, which rarely provide for capital increases or new business plans, must be targeted at firms actually capable of overcoming the crisis and not be merely a way for banks to put off booking losses. Small banks have provided support to the economy, including during the recession. They have expanded their business both outside their territory and with large customers. They must now make their governance arrangements, organizational structures and credit risk control systems adequate to their larger shares of intermediation. The cost and availability of the funds that banks can raise on the markets have been affected by the pressures on sovereign debts. Our leading banks have nearly completed their funding programmes for this year, albeit at higher costs and with 40 per cent in the form of covered bond issues. A third of the bank bonds now outstanding will mature by the end of 2012; this is a significant share but similar to that of the main European banks. Compared with the intermediaries of other countries, which rely more heavily on wholesale funding, our banking system benefits from a broad base of retail funding, which is relatively less sensitive to the volatility of the markets. Italian banks’ liquidity position, monitored constantly by the Bank of Italy, has remained balanced as a whole. Their holdings of assets eligible as collateral in Eurosystem refinancing operations are substantial; recourse to such operations is more limited than that of other euro-area banking systems. Since last year the Bank of Italy has asked banks to strengthen their capital bases. Shareholders, banking foundations and investors have responded readily. Between October 2010 and April of this year capital increases totalling more than €11 billion were launched. The majority of these operations will be completed by the autumn. They make it possible to approach the objective set by Basel III for 2019. It is commonly thought that an increase in banks’ equity translates into higher costs for customers and ends up braking the growth of the economy. However, quantitative studies show that a stronger capital base for banks has a positive net effect on the economy: it BIS central bankers’ speeches increases the system’s ability to withstand adverse shocks and reduces the likelihood of crises; for individual intermediaries, it reduces the risk premium on fund-raising and the cost of equity capital itself. A recovery in earnings makes it possible to increase capital internally. In 2010 the five largest Italian banking groups’ return on equity was again about 4 per cent, compared with an average of 7.8 per cent for twelve large European intermediaries. Sluggish asset growth, higher funding costs and low credit quality were the main factors. The gains in operating efficiency achieved before the crisis must not be lost. The rationalization of distribution networks must continue. Good governance encourages investors to supply capital. Cooperative banks listed on the stock exchange need more effective controls on the activity of directors, greater participation of the shareholders in the annual meeting, including by means of proxies. As I have had occasion to remark in the past, a legislative measure is necessary; amendments to bylaws, which we have nonetheless called for, cannot be the definitive solution. The quality of the banking foundations’ governance and internal control arrangements, the safeguards to preserve their independence and prevent conflicts of interest, and the efficiency and transparency of their financial operations are crucial in order to reconcile their holding bank equity with banks’ operating autonomy. In our country there was no banking crisis. However, the recession, by aggravating weak situations that already existed, has produced a rise in the number of provisional management, special administration and liquidation procedures. In line with international guidelines, we now have to revise the framework of rules in two ways: expanding the spectrum of crisis resolution measures; and giving the Bank of Italy, as supervisory authority, the power to remove corporate officers responsible for conduct harmful to the sound and prudent management of a bank. Suitable rules alone are not enough to ensure good supervision: without strong operating practices, without stringent and efficacious action, crises will not be averted. This has been made abundantly clear by the dramatic recent experiences. With the Bank of Italy’s supervisory role, our country has been able to count on a solid tradition. We have strengthened the most valid aspects of that tradition: the principles of a rigorous supervisory approach that was never converted to the “light touch”; supervision ready to persuade if possible, to prescribe if necessary, within the limits of law, performed by well-prepared and upright public servants. On-site supervision is now more closely targeted and more selective, with better use made of our resources. Targeted inspections and thematic inspections, which enable us to assess the same risk profile for multiple intermediaries, have taken their place alongside the all-encompassing inspections carried out at long intervals. We have forcefully safeguarded the principles of transparency and begun an open dialogue with the banking industry and the public, making good use of consultations on our measures. We are acting to strengthen the protection of banks’ customers, at one and the same time a civil value and an essential component of confidence in the banking system, failing which there can be no lasting stability. In this delicate phase in which the system is called upon to implement new, stricter international rules, the Bank of Italy is acting on two fronts: on the one hand, we are working in international fora to see that the rules take the specific characteristics of Italian banks into due account; on the other, we have worked closely with our banks to ensure that they fully BIS central bankers’ speeches conform with the evolving rules, especially the definition of capital components, and accordingly are able to stand up well under international examination. The results of this action up to now have been encouraging. It is in the interest of all to preserve them. *** The Governor’s annual concluding remarks have always represented an occasion for voicing assessments. This time they also provide the chance to look back over these five years. My constant theme has been the problem of our country’s economic growth. It is not a new problem, but I do claim for the Bank of Italy the credit for having made it the top economic policy priority. What kind of country will we leave to our children? Many times we have pointed to objectives, suggested lines of action, indicated areas for intervention. Five years on, seeing how little of all this has been translated into reality, the “useless sermons” of a far more illustrious predecessor of mine come to mind. Why doesn’t the political system – which alone has the power to translate analysis into law – take to heart Cavour’s dictum that “reforms, when enacted in time, do not weaken authority but reinforce it”? Thanks to hard work, ingenuity and sacrifice, in the 150 years of its history as a nation Italy has made enormous progress in the material conditions of life. We have experienced periods of booming growth. During the first fifteen years of the twentieth century per capita gross domestic product increased by 30 per cent. In the fifteen years following the Second World War, it rose by 140 per cent. In each of these historical periods Italy demonstrated a fundamental unity of purpose: in its capacity to withstand the trials of the First World War and in the civic and moral mobilization that, notwithstanding the heterogeneous political forces involved, resulted in our Republican Constitution. In other periods in our history, progress and growth were hampered by divisions, factional strife, a weakening of trust between the citizens and the State. Many disparities, above all that between North and South, have been overcome only in part. Diversity has been one of Italy’s historical characteristics, more than in other countries. Not infrequently, instead of being a source of enrichment the differences have been transmuted into mutual vetoes, the blockage of development. Our condition today is better in many respects. In large part, age-old conflicts have been superseded. The progress towards ever more advanced forms of integration in Europe and a new, shared diagnosis of the problems afflicting the economy in Italy offer good starting points. We must achieve unity of purpose on the fundamental lines of action. What unites us is more powerful than what divides us. Today, first of all the public budget must restored to its proper role as a factor of stability and an engine of economic growth, bringing it into balance without delay, revising the composition of spending to favour growth, and easing the heavy tax burden on so many honest workers and entrepreneurs. Economic growth does not stem solely from economic factors. It depends on public institutions, on citizens’ faith in them, on shared hopes and values. It is these same factors that determine the progress of a nation. To cite Cavour again: “A nation’s political resurgence can never be divorced from its economic resurgence. … Civic virtues, wise laws affording equal protection to each and every right, sound political arrangements, essential to the betterment of a nation’s moral condition – these are also the prime cause of its economic progress.” The intertwined vested interests oppressing the country in so many ways must be eliminated. This is an essential condition for joining solidarity with merit, equity with competition, for renewing the country’s prospects for growth. BIS central bankers’ speeches In March 2006, in my very first public speech as Governor of the Bank of Italy, I noted that the Italian economy appeared to be weighed down, but that its structural lags were not to be taken as signs of inevitable decline. They could be faced and matters clearly explained to the public, even when the solutions ran counter to the short-term interests of some segments of society. A few weeks later I opened my address to you in this forum with the words “Returning to growth”. It is with these same words that I would like to close these concluding remarks. BIS central bankers’ speeches | bank of italy | 2,011 | 6 |
Opening statement by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, and Candidate for President of the European Central Bank, to the Economic and Monetary Affairs Committee of the European Parliament, Brussels, 14 June 2011. | Mario Draghi: Opening statement to the Economic and Monetary Affairs Committee of the European Parliament Opening statement by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, and Candidate for President of the European Central Bank, to the Economic and Monetary Affairs Committee of the European Parliament, Brussels, 14 June 2011. * * * I am honoured to appear before your Committee for this hearing, which is part of the process of my nomination to the Presidency of the ECB. I trust you have read my CV. What I want to emphasize about my record are my professional experience in financial matters and as a central banker, and my long-standing commitment to the cause of the European construction. I have served as a member of the Governing Council and the General Council of the European Central Bank since 2006, in my capacity as Governor of the Bank of Italy. I believe that we have been able to deliver very positive results, although we were faced with exceptionally difficult challenges. I also took part in many of the decisions leading to the birth of the euro. In 1991, in my capacity as Director General of the Italian Treasury, I headed the Italian delegation negotiating the Maastricht Treaty. Subsequently, I was actively involved in many of the steps that were essential in ensuring Italy’s adoption of the euro, particularly the ambitious fiscal adjustment that took place in the 1990s. I have gained considerable experience in prominent European and international fora. Here, let me just mention that since April 2006 I have been Chairman of the Financial Stability Forum, which became the Financial Stability Board (FSB) in 2009. The FSB, which brings together national and international authorities responsible for financial stability and international standard-setting bodies, coordinates the work to develop and promote the implementation of effective regulatory supervisory and other financial sector policies. The more detailed information in my CV further clarifies my long-standing professional and academic experience in economic, monetary and banking matters. Today, I would like to concentrate my introductory comments on my assessment of the experience with EMU and on the main challenges that I believe lie in front of us. °°° Let me first of all say that I am honoured to be considered as a candidate for the Presidency of the ECB, because I believe that EMU, with the euro at its centre, has been a great success, a success that should be preserved for the sake of all the citizens of Europe. Let me state that none of the recent events, including the global crisis, call this fact into question. The euro has established itself as a credible and strong international currency, trade among the euro-area countries has been fostered, financial integration has been given an enormous boost. Price stability is now rooted in the conduct of economic agents: in the twelve years of the euro, annual inflation in the area has averaged just under 2 per cent, fully in line with the definition of price stability adopted by the Governing Council of the European Central Bank (ECB). This achievement is noteworthy, considering the headwinds the euro area had to weather, including substantial increases in oil and other commodity prices and the financial crisis. Thanks to the credibility gained over the years, the Eurosystem was able to keep inflation expectations steady during the crisis and to act with the speed and flexibility demanded by BIS central bankers’ speeches extraordinary circumstances. Without EMU, the response of the different monetary policies could not have been so rapid and decisive: it would have been practically impossible to achieve a similar level of coordination in the monetary field. This credibility must be preserved and I am fully committed to doing so. I believe its roots lie in the independence that the Treaty grants to the ECB to pursue its mandate of maintaining price stability. I also firmly believe that, as a counterpart of its independence, the ECB must ensure that in the exercise of its responsibilities there is the highest degree of transparency and accountability, first and foremost towards the citizens and their elected representatives in the European Parliament. I look forward to pursuing a fruitful, frank and open dialogue with your institution. We need responsible behaviour and decisions by all the parties involved, in the monetary, financial stability and economic fields. °°° Starting with monetary policy, it is of the utmost importance to recall that the credibility we have earned will not necessarily last forever; it cannot be taken for granted. An important challenge for the ECB is to manage the exit from the still very accommodative monetary policy stance and the phasing-out of the remaining non-standard measures. The measures adopted by the ECB were crucial to restoring orderly conditions on interbank markets, containing risk premia, and preserving credit flows to the economy in the worst phases of the crisis. We have avoided the collapse of the financial system, supported the functioning of the transmission of monetary policy to the economy and, ultimately, ensured price stability, thereby supporting the European economy. However, these measures are by their nature temporary. There have been a number of signs of normalisation in money markets and in the access to market-based financing by most banks in the euro area; the recourse to Eurosystem operations has declined. At the same time, concern about the sustainability of the public finances in some euro-area countries has led to strains in a number of banking sectors and a small number of institutions remain reliant on central bank liquidity, accounting for a substantial share of the overall refinancing volumes. The continued high degree of uncertainty about the macroeconomic and financial environment requires a careful assessment of the overall situation and outlook. Non-standard measures need to be phased out to the extent that they are no longer needed to support the functioning of the transmission of monetary policy to the economy; we must make sure that liquidity support to the economy is maintained as long as appropriate; but also that we do not sow the seeds of future imbalances and create addiction to our liquidity. At the same time, the setting of our policy rates must be adjusted with the aim of delivering on the ECB’s mandate, – to maintain price stability for the euro area in the medium term – in a pre-emptive manner, in order to avoid any deterioration of inflation expectations. It must be fully clear that neither the sovereign debt crisis nor the abnormal dependence of some banks on central bank liquidity can divert the ECB from pursuing its primary objective. °°° Secondly, challenges to monetary policy come from the area of financial stability. The financial crisis and the heightened emphasis on financial stability have raised a number of questions on the relationship with monetary policy. It has shown that a closer interaction is needed between macroeconomic and macroprudential analyses, although it has also brought out that there is no real trade-off between the objective of price stability and the support that the ECB can lend to other areas. BIS central bankers’ speeches In this respect, I believe that while synergies must be exploited to the full, the respective roles and responsibilities must remain clearly distinct. Monetary policy must keep its focus on preserving price stability over the medium term. As I just mentioned, the benefits of a sound monetary framework have been made more – not less – evident by the crisis. At the same time, monitoring the emergence of monetary and credit imbalances and asset price developments is one important element in a robust monetary policy strategy; a medium-term orientation is also crucial. The ECB’s monetary policy strategy already goes a long way towards taking these concerns into account. However, monetary policy is not necessarily the most appropriate instrument to deal with credit or asset price imbalances. The use of macroprudential instruments targeted on the sources of financial exuberance may be more appropriate. The new European supervisory authorities can make an important contribution in this respect. Let me just remark here that the ECB plays an important role in the European Systemic Risk Board (ESRB), to which it provides logistical, analytical and administrative support. An appropriate management of the interaction between macroprudential and monetary policy authorities will be crucial to success. The institutional arrangement adopted in Europe appears well-suited to address any problem that may arise from the management of monetary policy and new macroprudential tools. It will certainly be important for there to be dialogue between the two bodies on policy issues that can affect systemic risk. °°° Finally, let me mention the challenges to the construction of Europe itself. The sovereign debt crisis is a real test of the solidity of European institutions and of the political will in Europe to do whatever is needed to ensure the achievement of economic and monetary integration. The European surveillance of national budgetary policies proved to be inadequate. For a long time exceptionally favourable financing conditions have concealed the differences between member countries’ underlying conditions and economic policies and the absence of really binding common rules. The global crisis has accentuated investors’ perception of risk and revealed weaknesses in the architecture of the Union. The exceptional response of national governments and European authorities limited the risk of contagion and safeguarded the area’s financial stability. The financial support granted to the countries in greatest difficulty allows them to proceed with adjustment sheltered from market volatility. It is not a fiscal transfer between countries and it is subject to stringent conditions. There are no shortcuts available: the response to the debt crisis lies first and foremost in national policies, in the complete implementation of the adjustment plans that have been agreed. Solidarity among the member countries in the Union must be matched by a sense of responsibility and compliance with the rules. Looking ahead, I believe that the steps that have already been taken to tackle the weaknesses of the European architecture are important. The proposals of the EU Commission and the Council reinforce surveillance over budgetary policies. They can be made more ambitious by making procedures more automatic so as to shield them from the arbitrary nature of political negotiations. The European Parliament is having an important influence in this regard. The extension of rules similar to those governing national budgets to the surveillance of macroeconomic imbalances, with special consideration for the state of member countries’ external accounts, is also a very welcome development. BIS central bankers’ speeches Above all, structural reforms aimed at boosting economies’ competitiveness and growth potential must be a top priority on the policy agenda, not only in those countries hit by the debt crisis. In the end, the ultimate objective of EMU, and the measure of its success, is its ability to promote growth and economic and social welfare. Many of these matters are not the direct responsibility of the ECB, but the ECB can – and I believe must continue to – offer objective and independent advice, based on rigorous and credible analysis. I hope we will continue exchanging our views on these issues in the future. BIS central bankers’ speeches | bank of italy | 2,011 | 6 |
Dinner talk by Mr Ignazio Visco, Deputy Director General and Member of the Governing Board of the Bank of Italy, to the International Pension Workshop, jointly organized by Netspar and CeRP, Moncalieri, 16-17 June 2011. | Ignazio Visco: Pension systems in the midst of the demographic transition – the way forward Dinner talk by Mr Ignazio Visco, Deputy Director General and Member of the Governing Board of the Bank of Italy, to the International Pension Workshop, jointly organized by Netspar and CeRP, Moncalieri, 16–17 June 2011. * * * I would like to thank Giuseppe Grande for useful discussions and help. Ladies and gentlemen, good evening. I am very pleased to be here today, and to have this opportunity to share with you some thoughts on the global outlook for pension systems. This international pension workshop – jointly organized by Netspar and CeRP – has put together an impressive list of contributions in the fields of pension economics and pension finance. The papers explore key issues that are at the forefront of the current policy debate. This evening, I would like to offer a few thoughts on three topics: (i) The state of pension systems in the midst of the demographic transition; (ii) the to-do list for governments and industry participants ; and (iii) the long-term effectiveness of funded private schemes, with a focus on the crucial role played by strong and sustainable growth and the need to develop well-functioning annuity markets for the pension payout. I. The challenges facing pension systems Considering the current conditions of pension systems, it seems to me that the adjustment of pay-as-you-go schemes to the demographic transition is far from completed, because: (1) population ageing will continue; (2) most advanced economies will require robust fiscal consolidation measures; (3) in many of our countries the economic outlook will be weak for some time to come. First, the ageing process is going on, and dependency ratios continue to rise. Life expectancy will lengthen in the coming decades. According to the UN Population Division’s projections, in the OECD countries between 2010 and 2050 life expectancy at age 65 will increase by 3.1 years for men and 3.6 years for women. A second driver of change in pay-as-you-go arrangements is fiscal consolidation. One of the main legacies of the global financial crisis is the unprecedented size of fiscal deficits in many advanced economies. This has led several governments to phase in fiscal consolidation programmes over the short and medium term. At this stage, fiscal consolidation programmes are fairly well-defined, for example, in the United Kingdom and the euro area, though still somewhat hazy in the United States and Japan. Cuts in pension outlays (e.g., increase in retirement age, reduced benefits and restrictions on early retirement schemes) have been announced by a number of countries, as these measures are important for longer-term fiscal sustainability. Ageing will also affect fiscal sustainability through rising health and long-term care expenditures, something that is coming to be realized with a lag compared to pension expenditures. The third factor is the weak macroeconomic environment, because lower wages and fewer jobs shrink the revenues from pension contributions. The recovery from the Great Recession is expected to gain momentum only slowly and continues to be unstable, as indicated by the latest downward revisions of growth prospects for the United States. The recovery is also unbalanced: the advanced economies lag behind the emerging-market economies; global imbalances do not appear to be on the way of being reduced; in several countries households are highly indebted. BIS central bankers’ speeches Nor is the medium-term outlook for the world economy much brighter. In advanced economies public debt is high. The pressure of emerging market economies on energy and commodity markets creates upward risks for inflation. Labour market conditions are expected to improve only slowly and there is a concern that structural unemployment might increase. Geopolitical risks could remain high. If the public pension sector is not yet out of the woods, defined-benefit (DB) pension schemes are in no better shape. The demographic trends and the weak macroeconomic environment have had severe repercussions on them too. What’s more, DB plans have been put under pressure by the huge correction in asset prices triggered by the global financial crisis. The impact of the plunge in share price indices in 2008 has been magnified by the sharp decline in the yields on benchmark government bonds, which provide the backbone of the discount factors used to value future liabilities. As a result, since 2008 the funding gaps of DB plans have widened significantly across the board. According to OECD estimates, for more than 2,000 publicly traded companies headquartered in 15 countries, the median underfunding rate worsened from about one eighth in 2007 to one fourth in 2009. Since the autumn of 2010 the situation is likely to have improved but only slightly, owing to the low level of interest rates. Particular concerns have been raised about the sustainability of DB pension plans for public sector workers. There is evidence that in a number of advanced countries these plans produce potentially large net unfunded liabilities. In the public sector, pension promises tend to be relatively generous (sometimes to make up for lower current earnings relative to the private sector); in some countries, they are also partially funded or paid out directly from government revenues, or their valuation and disclosure may lack transparency. Because of these trends, retirement-income systems have continued to shift from public pay-as-you-go schemes and DB plans to defined-contribution (DC) pension schemes. In the United States, for example, over the last decade the percentage of workers participating in DB plans has declined further from 36 to 30 percent, while that of DC plan members has increased from 50 to 54 percent. The rising importance of DC arrangements implies that investment risks and longevity risk are increasingly borne by individual workers. Over the last decade, however, financial market returns have been disappointing, and the global financial crisis of 2007–09 has dealt a blow to the balances accumulated by many workers on their DC pension schemes. Especially hard hit were senior members nearing retirement. But the risk that DC schemes will deliver low income replacement rates is very serious also for young members. The disappointing performance of DC schemes over the last decade is likely to have sapped employees’ confidence in the ability of the financial markets to provide adequate and secure returns. Where membership is not compulsory, this may affect employees’ propensity to join DC pension schemes and pay pension contributions. The risk that DC schemes will provide a low pension income compounds the reduction in the coverage of public pensions. The possibility of policy reversals cannot be overlooked either. In this regard, it is telling that in some countries the choice of mandatory contribution to funded DC pension schemes has been called into question. II. What to do I now turn to some well-known policy responses to these challenges. While there is, I believe, wide consensus among academic experts and practitioners on the need for such responses, they are obviously demanding for policymakers. But it must be clear that delay in design and implementation could be very costly for our societies. First and foremost, people have to be encouraged to work longer. Living longer is certainly a positive development, especially if we are in good health (and this should not be taken for granted). But we need to have the resources to enjoy our longer lives, which means incomes BIS central bankers’ speeches and jobs. There is no question, then, that a return to what the G-20 defines as “strong, sustainable and balanced growth” is the fundamental objective of economic policy. This will help in furnishing the accumulation of funds necessary for retirement, but there is little question that the retirement age also has to go up. Statutory pension ages have started to rise in a number of countries. However, according to the OECD, in all but five member countries the projected gains in life expectancy over the next four decades will outstrip the prospective increases in retirement age. To insure the financial sustainability of pay-as-you-go schemes, possible measures include raising the retirement age, introducing incentives for later retirement, cutting benefits and indexing them to life expectancy (as it has been done, for example, in the notional defined contribution systems). It could also be helpful to allow senior workers to combine work with pension income. In this regard, it is worth recalling that there is no evidence that employment of older workers reduces the number of jobs available to young people. Second, for DC pension schemes to deliver on their promises, in my view there are three top priorities: a) DC plan members must be aware of the likely degree of coverage provided by their retirement scheme. This is a crucial condition to persuade workers to increase retirement saving and to help them set target replacement rates for their accumulation plan. Clear information on the expected replacement rates and their likely decline under adverse investment scenarios must be provided. b) Total costs to plan members must be reduced. As has been emphasized, among others, by the Turner Report in the middle of last decade and, more recently, by the Squam Lake Working Group on Financial Regulation, charges may have a major impact on the final balance accruing to plan members over an extended period of time. Costs can be reduced not only by increasing the volume of assets under management, with consequent economies of scale, but also by stimulating competition among pension schemes. This may call for various measures, including educating consumers about the effects of charges on pension fund returns; assuring transparency and comparability of charges between schemes; easing the portability of employer contributions between schemes; and intensifying competition among the financial institutions that manage pension funds. c) Sound default options should be designed. While the regulation of DC plans has to take into account the characteristics of the national pension system as a whole (for example, what share of pension income is provided by DC plans), a good practice would be to make enrolment in DC plans automatic but subject to an opt-out clause. Moreover, the default plan must be carefully designed. In order to encourage workers to join (or not to opt out), the default contribution rate could be rather low initially and rise gradually over time. Furthermore, the default DC plan should have low fees and diversified investment objectives, in order to ensure a fair balance between security and yield in investing retirement saving in financial instruments. These considerations also make it clear that the performance of DC pension schemes may be affected by workers’ degree of financial literacy, as has been highlighted by advanced scientific research. As was pointed out in the 2005 G10 report on Ageing and Pension System Reform, one of the policy challenges is to develop financial education programmes that “can help consumers avoid abuse and fraud, improve their investment choices, and raise their contributions to private pension plans”. Retirement-saving literacy programmes addressed to the labour force are thus important, although obviously they must go hand-inhand with stronger consumer protection. But developing a sound, robust DC pillar is not enough to ensure that the retirement income provided by private pensions is adequate. In pure DC plans, members remain exposed to extreme financial market risks, as we have seen in the recent financial crisis. This is a serious risk, especially for workers nearing retirement, who may not be able or willing to wait BIS central bankers’ speeches for a full recovery in financial markets. Moreover, severe financial turmoil is typically associated with weak labour markets and older job seekers who have trouble finding work may end up retiring earlier than expected (rather than delaying retirement), with lower pension incomes. The importance of extreme (financial and counterparty) risks in long-term financial contracts is demonstrated by the fact that in a number of countries guarantee arrangements are in place to protect benefits against the insolvency of the DB plan sponsor; for a worker, moving from a DB plan to a DC plan implies abandoning dual protection (the sponsor’s capital and the guarantee arrangement) in favour of no protection at all. This may call for some kind of return guarantee to DC plan members during the accumulation phase. Available examples include both absolute return guarantees (as in Japan or in some US states), in which the guaranteed return is set against a pre-specified return, and relative guarantees (as in Chile and Denmark), where the return is tied to some industry average or market benchmark. There is evidence that only guarantee schemes in which the minimum return is set at a very low or negligible rate, such as return of principal, can surely withstand adverse financial market conditions. This is consistent with the findings of our own research conducted at the Bank of Italy, which suggests that in order for the guaranteed return insurance scheme to be cost-effective, credible, and robust to moral hazard, the guarantee should be provided by the government and funded by properly risk-based premia. Another important challenge faced by pension systems is given by the changing nature of labour markets. Job mobility and flexibility may hinder the accumulation of retirement wealth. Pension schemes should allow for the fact that workers may change jobs and employers more frequently than in the past, and we should also think about ways to promote the crossborder portability of pension rights. Issues such as vesting periods and (implicit or explicit) penalty fees should be regulated and would be important to prevent any kind of predatory practice on retirement savings. Finally, the pension fund industry may benefit greatly from the development of retirement schemes in emerging-market economies, as these economies will also face more or less rapid population ageing in the coming decades, with pension systems still to be developed especially in their fully-funded dimension. With the current pace of increase in living standards and the emergence of a sizable middle class, the vast potential demand for retirement saving vehicles in these economies would allow the global financial industry to generate important economies of scale and scope. At the same time, given the sheer size of the potential saving pools, competition among financial institutions should be adequately promoted and the risk of an excessive concentration of market shares properly countered. III. Ensuring the long-term effectiveness of funded pension schemes But there are also two other factors which in the future will considerably affect the ability of funded pension schemes to meet their goal of providing pensioners with adequate retirement income. The first is the crucial importance of robust economic growth. The second is the design of the decumulation phase. Both funded and unfunded pension arrangements ultimately rely upon the ability of the economic system to create jobs and allocate resources to the most profitable investment opportunities. Economic growth is therefore the fundamental determinant of the sustainability and adequacy of any retirement system. However, as was highlighted in the IMF’s recent World Economic Outlook of the IMF, in the advanced economies potential output threatens to remain considerably below pre-crisis trends, unless financial and structural policies are significantly strengthened. Partly as a result of lower potential growth in the advanced countries, the weight of emerging market economies on world output is expected to increase steadily over the coming decades. In particular, Asia is expected to have a great potential for growth. According to recent projections by the Asian Development Bank, between 2010 and 2050 its weight will rise from about a quarter of global output in 2010 to at least a third in BIS central bankers’ speeches 2050 under a pessimistic scenario, and to half if the current trend of sustained convergence were to continue over the next forty years. If financial markets are well-developed, funded schemes make it possible for retirement wealth to expand at the same pace as that of the world economy. In order to do so, over the next few decades the asset allocation of funded pension schemes will have to gradually change its geographical scope, in order to reflect the rising weight of Asian and Latin American countries. It is important to observe that it is not a matter of keeping investment returns afloat by taking more risks. A reckless chase after high-yield assets around the world would be useless if not counterproductive. Retirement saving has to be directed towards those business activities that may put the world economy on a path of strong and sustainable growth. This raises a number of important issues for the global financial markets. On the demand side, pension schemes’ trustees and asset managers will have to devote more resources to the analysis of emerging market economies and the contribution of emerging market bonds and equities. Moreover, to the extent that the geographical composition of portfolios will become a key driver of the asset allocation, DC plan members will also have to improve their understanding of new investment opportunities. Regulation, at both the national and international level, will have to respond to the changing needs of institutional investors. We have to ensure that both individual and institutional investors are accountable for their actions. As for the supply side of financial markets, the challenges that we face may even be more demanding. First, if we want to ensure that financial markets keep track of the expansion of Asian and other rising economies, emerging market companies with good fundamentals and growth opportunities must have access to bond and equity markets. If the financial markets of the emerging market economies had limited capacity to absorb foreign resources, then capital inflows might fuel asset bubbles and even be counterproductive to economic growth in those economies. Second, while policies and practices may differ across countries depending on institutional and economic factors, there should be no uncertainty about some key policy areas, such as the governance of corporations, the legal and regulatory framework, the enforceability of contracts, and tax burdens. Finally, the financial infrastructures of both advanced and emerging economies should be integrated into the global financial system, open to foreign players, and compliant with international standards of transparency. The last key priority is the need to develop well-functioning annuity markets. In a few years’ time the number of pensioners for whom payout instruments will provide a significant fraction of retirement income is bound to increase, both in the advanced economies and in emerging and developing economies. At the moment, annuity markets around the world are rather thin, except in a handful of countries in which private pensions are more highly developed (such as in the United Kingdom, Switzerland, Chile and, to a lesser extent, the United States). Moreover, the payout phase arrangements differ markedly across countries, in terms of government intervention (through regulation and taxation), instruments and providers. Policy action in this field should target two broad objectives: the choice of the payout instruments and their costs. The first goal is to develop products that better protect against the risks that materialize during the decumulation phase, namely inflation, longevity and financial market risk. We have to think about how to achieve an inflation-protected stream of income for life after retirement, also taking into account the possibility that people in old age – while spending on health-care services – might increasingly be able to combine work and pension income. On this issue, as has been repeatedly observed, an adequate supply of government inflation-linked and ultra-long-term bonds is an essential tool to help financial institutions to offer inflation-linked annuities or other instruments that serve pensioners’ needs. Governments should also consider issuing longevity bonds, or providing financial institutions with guarantees against extreme (financial or longevity) risks. BIS central bankers’ speeches The second broad policy goal would be to reduce the price of annuities and similar instruments. In this regard, a main policy tool is the timely release of accurate mortality tables, both for the total population and for different subgroups in the population. Improvements in mortality tables would help reduce adverse selection costs and lower the premium for the aggregate longevity risk. Fostering instrument transparency and comparability is another useful option, as it would be to promote competition among annuity providers. IV. Conclusions The adjustment of pension systems to the demographic transition is a complex process that needs close monitoring and that will continue to unfold for a number of years to come. Doubts about the viability of public pay-as-you-go arrangements and defined-benefit pension schemes persist. More importantly, there are growing concerns over the ability of defined-contribution pension schemes to provide adequate income. Some of the issues that we are dealing with now were identified by pension experts and policymakers half a decade ago or more, but so far they have been addressed only in part. At the same time, new issues have come to the fore. I am convinced that the evidence that we have gathered so far on ongoing trends, industry practices and policies – corroborated by the findings of the most dependable scientific literature – provide clear guidelines on how to ensure that pension systems will fulfil their mission of giving workers a decent standard of living in retirement. Members of DC pension schemes must get sound information on their likely retirement income. The default options of DC plans have to be carefully designed. As the first waves of baby-boomers approach retirement, it is urgent to develop the markets for payout instruments. We have to promote competition among the providers of funded pension schemes and annuities. We have to be aware that market-based arrangements may not be able to cope with extreme financial or longevity risks. The centre of gravity of the global pension fund industry will increasingly shift towards the Asian and other emerging-market economies, both in terms of asset allocation and business opportunities. To conclude, one of my favourite quotes on longevity risk is Lorenzo the Magnificent’s rhyme of more than 500 years ago: “Youth is sweet and well / But doth speed away / Let who will be gay / To-morrow, none can tell” [trans. by Lorna de’ Lucchi, 1922]. In our world of increasing longevity and population ageing, we face the risk that expectations of limited economic growth (and the associated liquidity constraints) may reduce the propensity to save for retirement and make Lorenzo’s hyperbolic discounting an appealing though illusionary alternative. But in order not to be obliged to pay extremely high costs in the future we – individuals, market participants, policymakers – must shun any such illusion. There is no alternative to fostering economic growth by structural policies, maintaining incentives for retirement saving, facilitating the supply of long-term and indexed financial instruments, properly designing and protecting the pay-out phase, and upgrading the regulatory and supervisory framework. Thank you very much for your attention. BIS central bankers’ speeches | bank of italy | 2,011 | 6 |
Speech by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the "Les Rencontres Économiques d'Aix-en-Provence", Session 2, "Tension and new alliances - the currency wars", Aix-en-Provence, 8-10 July 2011. | Mario Draghi: Tension and new alliances – the currency wars Speech by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the “Les Rencontres Économiques d’Aix-en-Provence”, Session 2, “Tension and new alliances – the currency wars”, Aix-en-Provence, 8–10 July 2011. * * * Introduction The concept of “currency war”, coined by Brazil’s Finance Minister Guido Mantega in September 2010, is indicative of the tensions that pervade the international landscape at the current juncture. Indeed, in the past months, a number of countries have engaged in direct interventions in the foreign exchange markets or adopted some forms of capital controls. Let me offer a few thoughts on these issues. If we look back at the developments in the international monetary system over the past 30 years, we see that among advanced economies the era of competitive devaluations has come to an end. By the end of the 1990s, a large body of research had emerged pointing out the conflict between intervention in foreign exchange markets and the commitment of monetary policy to price stability. In the United States, the doubts about the effectiveness of sterilized interventions prompted their abandonment some time after the Mexican crisis. In Europe, the adoption of a single currency put an end to the realignments that had characterized first the “Snake” and then the first two stages of the European Monetary Union. Currency interventions in these economies are now made only in case of excessively rapid and large fluctuations. In the years from 1981 to 1997 the Federal Reserve intervened 453 times, more than 30 interventions per year on average. In the last 12 years, in contrast, it has intervened only twice, on September 2000, when the euro had reached a record low against the dollar, and on 18 March this year, in the aftermath of the earthquake that hit Japan. The European Central Bank has intervened only four additional times, in September and November 2000. Japan has been somewhat more reluctant to abandon currency interventions, because of the continuing upward pressures on the yen in the face of a troubled slow-growing economy. Yet, after 2004, it has intervened only twice, on September 2010 and this year in the days following the earthquake. The determination of exchange rates between the dollar, the euro and the yen has been thus left entirely to market forces. Fluctuations have been large: over the past 20 years the ratio between the minimum and the maximum value of the dollar-euro and dollar yen exchange rates was almost 2:1. But the large size and the high level of economic development of these economies make them resilient to currency fluctuations, as the exchange of goods, services, and financial assets mostly occurs within each area, while the presence of deep forward and futures markets facilitates currency hedging. This situation contrasts with that prevailing in emerging economies, where policy measures to managing the exchange rate have been the norm. The desire to limit the effects of large swings in exchange rates on the real economy, and the difficulty of insuring against them, were certainly an important reason. But there are other reasons as well. Perhaps the most important is that managing exchange rates allowed countries to pursue a strategy of exportled growth. Moreover, especially after the Asian financial crisis, the wish of building up large precautionary reserves has played an important role. These policies, as we know, favored the building up of the large imbalances between surplus and deficit countries, which provided the economic precondition for the international crisis. In the aftermath of the global crisis timely and internationally coordinated policies were fundamental to avoid a new Great Depression. Crucially, and in sharp contrast with the experience of the 1930’s, there was no large-scale recourse to protectionism or to competitive BIS central bankers’ speeches devaluations. To be sure, an underlying demand for protectionist measures has never been muted, as globalization represents a threat for monopolistic rents, and inevitably increased with the crisis. Not surprisingly, during the crisis, 17 of the G20 countries introduced protectionist measures, despite the pledge to avoid them signed in November 2008 by the G20 leaders. However, most of them were very narrow in scope and their impact on the volume of international trade has been negligible. Fundamentally, countries are now more aware that they are interdependent through supply chains and imported inputs. Moreover, as it often is the case, many protectionist measures, including the so-called “Buy America” provision, appear to have been circumvented. Furthermore, WTO agreements now provide greater legal stability for trade relations. The quick recovery of international trade following the end of the Great Recession owes a lot to the fact that the world has avoided currency and commercial wars. The current situation Overall, a cooperative environment prevailed. Overtime, however, with the recovery taking ground the situation has somewhat changed. Today the danger that an uncooperative game could gradually gain ground is much more material than only a couple of years ago. A number of features of the present global conditions are behind this risk. First, the recovery is very uneven. This implies that domestic economic policies are confronting very different conditions at home and are thus moved by different, not necessarily consistent, objectives. With the notable exception of Germany, economic growth remains feeble in the advanced countries, too slow to help redress seriously weakened fiscal balances and unemployment rates. Expansionary policies have exhausted their margins of maneuver. The need to end the exceptional support to the economies provided by fiscal and monetary policies in the last three years is undisputed. Absent action, debt sustainability problems and higher global long term interest rates are a certainty. In emerging economies, there are instead signs of overheating, with rising inflation and strong credit creation. Some monetary policy tightening has taken place but real interest rates remain very low or even negative in many countries. Capital inflows are for many countries back at the high pre-crisis pushed by global monetary and financial conditions that remain very accommodating. Monetary authorities are refrained from increasing interest rates further by the fear of spurring larger inflows. As a consequence capital controls and other prudential measures are used, which may provide relief in the short term but also generate distortions over longer periods. Second, the recent experience has confirmed that the world has become multi-polar, with emerging markets representing a new pole of autonomous growth. However, we have not yet moved to a multi-polar monetary system. One important reason is that countries are at very different stages of financial development. The demand for advanced economy assets remains very strong and the dollar is still at the center of the system. Strong capital flows to emerging economies are natural and even desirable as these economies offer the highest perspective returns, but in many countries they continue to be exceeded by capital outflows into advanced-economy debt, especially into the US. Third, macroeconomic imbalances are increasing again after a temporary retrenchment during the crisis mainly due to a depressed demand in deficit countries. They reflect a continuation of the unbalanced pattern of savings across the globe and make the international landscape much more vulnerable to the risks of sudden reversal in market sentiment and risk appetite and/or changes in the interest rate cycle. This situation of the international monetary system is bound to generate suboptimal outcomes and, especially, risks to the global financial stability. The existence of one major reserve currency can make exchange rate fluctuations more abrupt; at the same time it limits the scope for markets to discipline macroeconomic policies in advanced deficit economies BIS central bankers’ speeches (especially the US). Thus far only limited realignment of exchange rates in emerging market economies with large surpluses took place. The pegging of exchange rates to the dollar affects the exchange rate of third countries away from fundamentals. In emerging market economies with flexible exchange rates and open capital accounts, large capital inflows have pushed up their exchange rates, in some cases into overvaluation territory (for example, in Latin America). The insufficient adjustment of exchange rates and of macroeconomic imbalances may lead to disorderly policy reactions and encourage beggar-thy-neighbor policies. The way forward The priority for the international community is to avoid that current disequilibria degenerate in a disorderly adjustment. We need determined action in a number of fields. First and foremost, a rebalancing of global demand is key for a sustainable recovery. Advanced economies need to tackle the debt problem: fiscal consolidation and reduction of leverage in the private sector, must be accompanied by structural reforms aimed at spurring potential growth. In large fast-growing emerging markets, especially in China, excessive saving should be curbed; this implies a gradual shift away from a purely export-led model that must be supported by a correct set of policies, including introducing social safety nets in order to facilitate the reallocation of workers across sectors and reduce precautionary savings. More currency flexibility can support the rebalancing of demand. In large surplus emerging economy, most notably in China, allowing the currency to appreciate gradually by not reinvesting surplus funds into advanced economies’ assets would also help to reduce inflationary pressures. Second, a more sustainable pattern of global demand can be reached only by reinforcing international cooperation and multilateral surveillance. An important step in this direction was made at the 2009 Pittsburgh Summit, where the G20 pledged to work together to set the world economy on a path of strong and sustainable growth. The G20 “Framework for Strong, Sustainable, and Balanced Growth” and the “mutual assessment process” (MAP), are crucial to identify common objectives and the required actions to reduce imbalances. It is indeed a demanding task as the Seoul Summit last year and the current process within the G20 this year have shown. Third, even in the most favorable scenario a rebalancing of global demand will take time: macroeconomic imbalances and the associated large capital flows across major economic areas will continue for some time. They must be financed in an orderly manner. The reform of the global financial system remains essential to be able to rely on a more solid and efficient financial sector than we had in the past. Fourth, while the credibility of the WTO rule-based system has survived the recent global recession, current agreements still leave too many domestic markets (particularly in services) effectively insulated from the beneficial pressures of foreign competition. It must be avoided that the delay of a successful conclusion of the current round of multilateral trade liberalization – the Doha Round – leaves a hole that would be probably filled in by less efficient and less equitable bilateral trade agreements. Concluding, I do not think there is an explicit currency war, but the risk of diverging and uncoordinated national policies, focused exclusively on an internal dimension and short term objectives, is becoming more worrying. We must make our policies more global, more aware of the need of taking into account the impact they have on each other. The international community has shown to be able to work together to avoid a collapse of the global economy. Now it has to prove that it is able to do the same even at a time when the emergency is behind us, but we are still confronting very serious challenges. BIS central bankers’ speeches | bank of italy | 2,011 | 8 |
Address by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the Annual Meeting of the Italian Banking Association Rome, 13 July 2011. | Mario Draghi: Italy’s path towards stable growth Address by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the Annual Meeting of the Italian Banking Association Rome, 13 July 2011. * * * The crisis and the euro Growth prospects and the financial markets are being influenced by the sovereign debt crisis. Despite the decisions taken by the Greek Parliament and the Eurogroup, the tensions have increased and spread, partly owing to the inertial nature of processes of this kind. It is essential that the countries that have agreed an adjustment programme with the European Union and the International Monetary Fund continue the considerable efforts they have made to date. The European Council has reaffirmed its commitment to the financial stability of the euro area. In no country is there an alternative to credible fiscal consolidation, the necessary, but not sufficient, condition for strengthening the outlook for growth. For years interest rates in the various parts of the euro area did not diverge significantly from those obtaining in Germany. For a long time the spreads between sovereign securities and German Bunds remained narrow and the interest rates charged by banks reflected the credibility of the public securities of the euro-area countries. This is no longer the case: the solvency of sovereign states has ceased to be a foregone conclusion but something that has to be won in the field with rapid and sustainable growth, which is only possible with sound public finances. Interest rates reflect today’s new situation: they are higher for countries with low growth and weaker public finances. The cloak of credibility provided by the stronger euro-area countries has been lifted; we must grow without relying on its shelter. The structural reforms invoked for years are now even more crucial. On several occasions I have noted that Europe reacted to the global financial crisis by drawing on the credibility of the ECB and the latter’s timely and innovative conduct of monetary policy and by equipping itself with a more appropriate set of economic governance tools. We now have a system of autonomous authorities for banking and financial supervision, a European body to monitor and mitigate systemic risks, and new procedures for the coordination of fiscal and structural policies. The present crisis is also an opportunity, however, to reflect on the limits of the action taken to date at European level. A new phase has begun. It has to be recognized that in the handling of financial crises recourse has not infrequently been made to partial and temporary measures, thereby increasing the uncertainty on financial markets. It is now necessary to give certainty to the procedure for handling sovereign crises: by clearly defining the political objectives, the instruments and the volume of resources. This is needed to ensure the stability of the area and its currency, and to take full advantage of the strength of its economy and monetary and financial situation. The Italian economy The Italian economy is benefiting from the expansion of world trade. Compared with many other advanced countries, it has the advantage of a solid banking system. The unemployment rate has been falling since the autumn. After six months of barely positive changes, in the second quarter Italian GDP grew at a rate in line with the euro-area average. In the medium term the growth rate of the Italian economy is expected to remain below that of our main European partners. The Bank of Italy’s Economic Bulletin, to be published on Friday, will contain our detailed assessments for 2011–12. BIS central bankers’ speeches The tensions of the last few days involving Italian government securities and share prices were due in part to the uncertain outlook for the public finances. The budgetary adjustment prepared by the Government is an important step in the consolidation of the public finances. The measures before Parliament give impetus to the process of reducing the public debt. This year will see a significant primary surplus; according to European Commission estimates, next year it will grow further and be the largest in the euro area. Having moved in advance of the normal deadlines, the additional measures needed to achieve a balanced budget in 2014 must now be rapidly established. This is what the markets are mainly looking at. There is a risk that these measures will distort the structure of the adjustment, appropriately based to a large extent on expenditure cuts. Unless other expenditure items are also cut, it will not be possible, however, to use the power to enact tax and welfare reforms to complete the adjustment in 2013–14 without raising taxes. But, as for the other euro-area countries, the consolidation of the public finances must be accompanied by an increase in our economy’s growth potential by the timely adoption of effective and credible structural policies, together with consistent behaviour on the part of all the key figures in the country’s political and economic life. The regulation of international finance In my latest Concluding Remarks I referred to the agenda for the coming months: after establishing the requirements for capital and the measures to be adopted with regard to leverage and liquidity, the Financial Stability Board and the Basel Committee, at the instigation of the G20, are now working on the two main issues that remain to be addressed: systemically important financial institutions (SIFIs) and the shadow banking system. Proposals will be submitted to the G20 in November. With regard to SIFIs, the proposals are now broadly established. Before the end of the summer there will be a public consultation on the mechanisms for overcoming crises and the measures needed to increase SIFIs’ ability to absorb losses. Provision is made for global SIFIs to have a larger capital endowment than other intermediaries. The additional buffer for the SIFIs that are identified is to vary between 1 and 2.5 per cent of their risk-weighted assets, depending on their systemic importance as measured by an indicator that takes account of their size, complexity, interconnections with other intermediaries, international operations and specialization in certain fields of activity. The augmented requirement will have to be met with capital of the highest quality. Implementation will proceed gradually starting in 2016. The new regime will be fully in force at the beginning of 2019. As for the shadow banking system, the Financial Stability Board has decided to concentrate on highly leveraged activities that involve maturity transformation or that can give rise to regulatory arbitrage. Proposals are being prepared. In Italy, financial regulation, which has recently been strengthened, already covers all the financial institutions that deal with the public. A frequent topic concerns the effect of the new international standards on bank-based systems, such as Italy’s, with a large number of small and medium-sized enterprises; it is rightly noted that banks with basically different balance-sheet structures and equally different risks should not be treated in the same way. The risk-weighting of banks’ assets is crucially important. Basel II assigned a much lower weight to purely financial activities than to lending, in which Italian banks are specialized. This is why Italian banks, when subject to international comparison on the basis of current data, appear better capitalized in terms of financial leverage than risk-weighted assets. The decision to treat financial assets more favourably was based on the implicit assumption that BIS central bankers’ speeches the markets in which they were traded would always be liquid. The crisis dramatically demonstrated the fragility of this assumption and the need to rebalance the system of weights. This is the direction taken with the recent regulatory reforms, against the background of a significant overall strengthening of the quality and the quantity of capital. Recently, the capital requirements for trading portfolio exposures have been increased and the prudential treatment of the risks associated with securitizations and off-balance-sheet vehicles has been tightened. Basel III has increased the stringency of the calculation of the capital requirements for counterparty risk in connection with derivative transactions. The whole matter is now undergoing a fundamental revision by the Basel Committee in order to eliminate any discrimination of loans with respect to trading assets. The Bank of Italy is working in the technical fora to proceed in this direction with determination. At the same time (it is worth recalling) the new rules confirm the facilitations, already present in Basel II and invoked by the Italian supervisory authorities, that, other things being equal, allow a lower weighting for loans to small and medium-sized enterprises. The Italian banks and the action of the supervisory authorities Italian banks have shown, and continue to show, an ability to resist and react in times of difficulty, not only at the height of the financial crisis, when they were saved by a model firmly rooted in core banking business, but also in its aftermath, when the crisis gave way to a deep recession in all the advanced countries that hit Italy particularly hard because it came after a decade of stagnation and was followed by a slower recovery than elsewhere. In the three months to May bank lending to households and firms grew at an annualized rate of 5.7 per cent, well above the euro-area average of 2.2 per cent. Lending to firms grew by 6.1 per cent and that to households, driven mainly by loans for house purchases, increased by 5.2 per cent. The rapid expansion in lending to firms is ascribable to the growth in demand, sustained by the need to finance inventories and working capital. The deterioration in credit quality was much less serious than during the recession of the early 1990s, which was not as deep. Although still substantial, the flow of adjusted bad debts, especially of firms, is beginning to show signs of slowing. Compared with a year earlier, in April there was a decrease in banks’ exposure to borrowers reported for the first time with positions classed as bad debts. There has not been a housing bubble in Italy; the banks’ losses in this sector have been limited on the whole and have not sparked a crisis. The low level of nominal interest rates has helped to avoid a vicious circle in which borrowers with temporary liquidity difficulties suddenly become submerged by financial burdens even when the firm’s economic prospects are good. The banks benefited from strong local roots, which ensured stable sources of funds and underpinned the qualitative assessment of their creditworthiness, and from a fundamentally unadventurous corporate culture. The test was, and still is, a hard one, though. We insisted that the banks strengthen their capital without delay. This was not only because they need to move progressively into line with the new international standards, but also because the present situation demands it. They responded without hesitation, giving the lie to the sceptics. Their shareholders, including leading institutional investors, understood the need for this step. Since the beginning of this year the Italian banks have made or approved huge capital increases. BIS central bankers’ speeches The core tier 1 ratio of the five largest banking groups averaged 7.4 per cent at the end of 2010; in March it had increased to 7.8 per cent and it is estimated to have risen further still, to 8.6 per cent, as a result of subsequent recapitalizations. The banks have readied themselves in time for the European stress tests, as we asked them to do, and the results will be published in a few days’ time. We are confident they will be well above the threshold of 5 per cent for the core tier 1 ratio. The capital strengthening that the Italian banking system needs to implement in order to meet the new Basel III requirements by 2019, which was estimated at €40 billion in relation to June 2010, is now about €20 billion. We are making good progress. For the future, the progressive increase in banks’ capital will be essential to ensure the growth of lending while guaranteeing the sound and prudent management of the banking system. It is very important that the tax treatment of intermediaries should not discourage them from strengthening their capital. It was a wise decision to bring bank bond issues scheduled for 2011 forward to the beginning of the year. The volume of securities already issued by the leading banks is equal to the entire stock of bonds due for redemption during the year. Despite the sacrifice in terms of cost, both gross and net bond funding has increased significantly, the former totalling €31 billion from July 2010 to June 2011 whereas it was negative twelve months earlier. Overall, deposits and bonds rose by 1.8 per cent in May compared with a year earlier. The Bank of Italy continues to call on the banks to maintain balanced liquidity positions. This policy was introduced well before international liquidity standards were first discussed in Basel. It has helped to shelter the Italian banking system from the financial storm; it continues to be necessary in the face of persistent market instability. Convergence towards the Basel liquidity standards, the details of which are not yet fully defined, will take place gradually, according to plan. In the first quarter of 2011, the profitability of the five largest banking groups improved somewhat with respect to a year earlier. The annualized rate of return on equity rose from 3.0 to 3.4 per cent. Losses on loans decreased by 12 per cent, but they still absorb almost half of the banks’ operating profit. The improvement is encouraging; it should continue in the coming months when the recovery in lending reflects positively on banks’ earnings. However, for the banks to return to satisfactory profitability it is essential that they persist with their efforts to reduce costs. Some groups are taking steps to rationalize their networks; these must be pursued with determination. A difficult round of labour negotiations awaits the banks, during which they must reconcile the need to reward the professionalism and productivity of employees with the impelling need to ensure that the evolution of costs is in line with the sector’s economic prospects. *** There are favourable factors we can rely on to carry forward the consolidation of the public finances, overcome the emergency now overshadowing the economic outlook, and set Italy on a path towards stable growth. We have the advantage that private sector debt and the country’s overall net foreign debt are both limited. Our banks are sound; they have emerged unscathed from the financial crisis that shook large foreign institutions. We possess fundamental resources that have always characterized the Italians: individual initiative, ability to innovate, willingness to work. We must believe in our economy’s capacity for growth. We must find a common goal, above and beyond individual and factional interests. We must rediscover how to act for the good of all. BIS central bankers’ speeches | bank of italy | 2,011 | 8 |
Keynote address by Mr Fabrizio Saccomanni, Director General of the Bank of Italy, at the Conference on the International Monetary System: sustainability and reform proposals, marking the 100th anniversary of Robert Triffin (1911-1993), at the Triffin International Foundation, Brussels, 4 October 2011. | Fabrizio Saccomanni: How to deal with a global Triffin dilemma Keynote address by Mr Fabrizio Saccomanni, Director General of the Bank of Italy, at the Conference on the International Monetary System: sustainability and reform proposals, marking the 100th anniversary of Robert Triffin (1911–1993), at the Triffin International Foundation, Brussels, 4 October 2011. * 1. * * Introductory remarks I am very happy and honoured to have been invited to speak at this conference celebrating Robert Triffin’s 100th birthday and I am glad that the Bank of Italy has been able to support this initiative of the Triffin Foundation. I had a first opportunity to learn Triffin’s provocative and prescient ideas about the working of the world’s monetary system as a student of international economics at Princeton in 1969–70. Shortly after that, I was privileged to witness the fulfilling in August 1971 of Triffin’s prophecy about the downfall of the Bretton Woods system from the vantage point of the IMF where I served as an economist. In subsequent years, I was fortunate to meet Prof. Triffin in person on several occasions, as he was a frequent visitor to Italy to attend conferences and seminars on international monetary reform, a topic which has been given traditionally a high priority in the research agenda of the Bank of Italy. Triffin published many of his seminal contributions to international monetary theory in the Banca Nazionale del Lavoro Quarterly Review, a prestigious Italian scientific journal. In recognition of his close relationship with the Italian academic and financial community, Triffin was awarded, in 1987, the San Paolo Prize for Economics by a jury presided by Prof Paolo Baffi, a former Governor of the Bank of Italy. In his presentation of the award, Baffi praised Triffin as a “cosmopolitan scientist” who had devoted his life to the pursuit of international monetary order in Academia, in Central Banks and in international organisations, in a splendid career that had seen moments of great satisfaction as well as of deep bitterness. But, Baffi noted “I do not believe that any intellectual gratification that he may have derived from the infallible accuracy of his forecast can alleviate his dismay of cosmopolitan scientist in the face of the utter mismanagement that currently afflicts the international monetary system”. Indeed I can vividly remember that Triffin in his late years was not only disappointed by the failure of the reform of the international monetary system, but was really angry and indignant at what he regarded as an irrational and incompatible behaviour of the countries bearing the main responsibility for the management of the world economy. It was, in his own words, an international monetary scandal and he was infuriated by it. I have no doubt that Robert Triffin would be equally infuriated, if not more, by the current state of the international monetary and financial system, still beset by the global crisis set in motion by the seizure of the US subprime mortgage market in August 2007. The fact that the crisis has now moved to Europe and is destabilising the eurozone would certainly be a cause of deep regret for Triffin, who firmly believed that regional monetary integration in Europe could contribute to fostering stability in the world’s monetary system. In the age of financial globalisation, unfortunately, this assumption no longer holds true. In my remarks today I will briefly review what is wrong with the present international monetary system and will try to argue that there is an urgent need to give new impetus to the reform agenda originally agreed within the G20, if we want to deal with the “global Triffin dilemma” that is currently threatening the stability of the world economy. BIS central bankers’ speeches 2. What is wrong with the present international monetary system? The past twenty years have been characterised by significant exchange rate misalignments, large and persistent external imbalances and the accumulation of huge stocks of official reserves. I believe that these phenomena are symptoms of an inefficiency of the present international monetary system. Since the move to floating in 1973, flexible exchange rates have not behaved according to textbook predictions: – Their volatility has exceeded what could be justified by shocks to fundamentals. – Persistent misalignments have emerged among the major currencies. – Partly as a result, many countries have been reluctant in practice to allow full exchange rate flexibility (“fear of floating”), resorting to various forms and degrees of exchange rate management. Both policy failures and market failures have been responsible for this: – Misguided and unsustainable policies have frequently been a source of macroeconomic uncertainty and structural distortions. Exchange rate policies and capital controls have often been used to prevent the correction of misalignments. – At the same time, market exchange rates are not guided by fundamentals in a reliable way, partly because market participants (as also economists) do not seem to share a common view of what those fundamentals are. All this can be summarised by saying that flexible exchange rates have proved not to be an effective and reliable mechanism for enforcing policy discipline. Markets sometimes fail, even for long periods of time, to focus on fundamentals, only to suddenly “wake up” and enforce a correction that, being too late, is often inefficient, costly and traumatic. As we know from recent experience, this pattern applies to credit risk premia as well as to exchange rates. Market-based discipline alone is not enough. The emergence of large and persistent external imbalances over the past twenty years is closely connected to the lack of an effective policy discipline. – Some of the countries with the largest surpluses and deficits have been under no effective pressure from the markets to correct the imbalances. China and oil exporting countries seemed to be able and willing to continue to accumulate reserves almost indefinitely. As a result, the United States, issuer of the principal reserve currency, faced a highly elastic demand for its dollar liabilities and therefore did not need to incur either currency risk or a rising cost in financing its deficit. – However, exchange rate manipulation was just an element in a broader constellation of structural factors and policy settings, in both surplus and deficit economies, that allowed the imbalances to persist. Neither multilateral surveillance nor peer pressure had sufficient “teeth” to induce a correction of those policies before the crisis. Although the imbalances declined during the recent recession, this was largely due to cyclical factors, and they are now starting to widen again. They remain a potential source of strain for the global economy and financial systems. The accumulation of large stocks of official reserves has reflected in part a widespread desire to accumulate precautionary buffers in the face of increasingly large and potentially volatile capital flows; in part an effort by a number of countries BIS central bankers’ speeches to maintain undervalued exchange rates to support export-led growth. Both drivers, in different ways, point to weaknesses and inefficiencies of the present international monetary system: – The accumulation of precautionary reserves is costly, as the return on reserve assets is typically lower than the country’s borrowing costs. Moreover, even countries holding large a buffer may face constraints in actually using it, if a falling reserve stock is perceived by the market as a negative signal. – Moreover, if a country accumulates reserves to forestall an overdue exchange rate appreciation it may eventually face substantial capital losses. In addition to being inefficient for the reserve holders, the accumulation of large official reserves has undesirable spillover effects on the international monetary system: – Since reserves are held predominantly in US Treasuries, strong official demand tends to compress yields, causing financial market distortions. For example, in the years leading up to the crisis it contributed to trigger a global “search for yield”. – In addition the seemingly insatiable global demand for dollar reserves allows the United States to enjoy the “exorbitant privilege” of financing external deficits in its own currency at a low cost, thus blunting the incentive to adjust. 3. Towards a multi-polar system? The central role of the US dollar is connected to several features of the functioning of the present system that I have just outlined. How can that role be expected to evolve? Will the system remain essentially dollar-centered or become more multipolar? I believe that over the next few decades we will probably see an evolution toward multi-polarity, although the shift is likely to be gradual. Some trends are relatively easy to identify, others less: – The US dollar is likely to remain the main international currency in the near term. The shares of other currencies may grow over time, but inertia due to the dollar’s incumbent advantages will tend to slow the process. Specific events could trigger an acceleration, but this is hard to predict. – The future role of the euro will largely depend on how we come out of the present crisis. I think we now stand at a crossroads: either the euro area institutions are strengthened and this allows the single currency to regain its attractiveness and to develop into a true global currency; or, if the crisis is allowed to fester, even the euro’s role as a regional currency will be in doubt. – Given China’s growing importance in global trade and its links to a fast-developing East Asia, it appears almost inevitable that over the next 10–20 years the RMB will become an international currency alongside with the yen, at first regionally, later perhaps on a broader scale. However, it may take some time for the process to take off, as some essential pre-requisites (such as full convertibility) are still lacking. – Regional cooperation arrangements, such as those that exist in the European Union and the Chiang Mai initiative in Asia, could become part of this multilateral system. BIS central bankers’ speeches How would a multi-polar system work? In principle, being more “balanced”, it may even alleviate some distortions of the present system. In particular: – The demand for US dollar reserves should in principle become less elastic, thus diminishing the United States’ “exorbitant privilege” and allowing market discipline to work more symmetrically. – If a number of Asian countries were to peg their exchange rates to the RMB (or to manage their exchange rate policy with reference to it), it may be easier for China’s authorities to accept greater exchange rate flexibility vis-à-vis other currency areas. But could the coexistence and competition between two or more reserve currencies be a source of instability? My own view is that, although not necessarily unstable, a multi-polar system probably requires a high degree of international cooperation. – At present, both the high degree of financial integration among economies and the awareness of their interdependence have made the costs of isolationist or non-cooperative behaviour more evident than in earlier periods of systemic transition such as in the interwar years. – However, having stronger incentives to cooperate is not enough. We also need a greater capacity to do it, which means having an effective political leadership and the right institutions. We know from experience that the ability and willingness of national policy-makers to act cooperatively, even in the face of a clear and present danger, cannot be taken for granted. Does the SDR have a role to play in the future evolution of the IMS, either as a complement to the existing reserve instruments or, in a longer-term perspective, as a forerunner of a true global currency on which the IMS could be centered? – At present, the role of the SDR is very limited. Allocated SDRs cannot be used directly to conduct interventions. More than a true reserve asset, they are a tool for redistributing reserves, for countries that cannot borrow them on the market. There is strong resistance to expanding the SDR’s role on the part of several IMF member countries. The SDR is seen as an unconditional form of credit, giving rise to moral hazard. And central banks see the risk of politically-driven SDR allocations stoking global inflation. – It has been suggested that developing “private SDR markets” (in analogy with the experience of the private ECU in the 1980s and 1990s) could be a way of making SDRs more attractive as reserve assets and expanding the SDR’s role as a unit of account in trade and finance. The ultimate goal would be to create the conditions for an expanded role of the SDR in the international monetary system. To jump-start this process, public authorities could undertake coordinated actions such as issuing SDR-denominated debt, helping create market infrastructures and providing legal certainty. – I believe that in order to have a chance to work in practice, such actions would need to be part of a long-term strategy supported by a strong political commitment. My understanding of the experience of the private ECU is that a key factor of its success was the link to the long-term process of European monetary integration, which provided not only a legal, economic and institutional frame of reference but also a strong political constituency. By analogy, making the SDR a credible reserve asset and unit of account for both official and private agents would probably require a commitment to eventually transform it into something more than a basket, i.e. a currency in its own right. As we know, we are still very far from having a broad consensus on such a prospect. BIS central bankers’ speeches 4. The reform of the international monetary system: the role of the G20 and of the IMF To summarize, we have an international monetary system that lacks an effective mechanism for ensuring the mutual consistency of national policies. The costs of this in terms of distortions and instability are already evident, and will probably be further exacerbated as the world becomes more integrated economically and financially. On top of this, as we move toward a multipolar system we will need even greater cooperation to manage this process and contain the risk of instability. Indeed, the need to review the functioning of the international monetary system was put on the G20 agenda early on after the crisis. Following some bold G20 statements, there was even hope that a “new Bretton Woods” system could be shaped under the aegis of the G20. In this spirit, a group of former senior policy-makers assembled by Michel Camdessus, Alexandre Lamfalussy and Tommaso Padoa-Schioppa (the Palais-Royal Initiative) chose to emphasize in their report the great urgency of tackling the reform of the international monetary system, and proposed a number of significant and far-reaching changes in the current arrangements. But despite the best efforts of the French Presidency, the G20 work agenda has been fragmented into a variety of “silos”, which are meant to distil specific “deliverables” for the Leaders at their next meeting in November. Thus, the global vision has been lost. In addition, progress on specific fronts has been rather modest so far, reflecting countries’ conflicting views on many such aspects – The most promising workstream is the Mutual Assessment Process (MAP). Quite frankly, I do not see other substantial IMS-related deliverables for the Cannes Summit. On issues such as global liquidity, capital flows, reserves, and the SDR, countries’ views are too divergent to imagine real progress. – So far, the record of the MAP has been mixed. The MAP is a peer review process “owned” by the G20 (the IMF only provides technical support). It is aimed at defining (and then monitoring the implementation of) a set of mutually consistent policies to achieve a rebalancing of global demand and restore conditions for growth. But economic imbalances are still wide and worrisome. The G20 has failed to deliver reassuring massages to markets. Why? I see two main reasons. First, the whole process is bound to remain rather cumbersome reflecting the need to maintain G20 “ownership” – i.e., to reflect the inherent diversity of its members and the rule of consensus used in its deliberations. More importantly, the MAP has been conceived as an exercise with a medium to long term orientation, not as a platform for discussing national policy changes dictated by the evolution of G20 economies in the short term. Explicit discussion of exchange rates has been taboo, which is a serious limit. And reconciling short-term objectives (supporting growth) with medium-term goals (rebalancing) is a challenge, particularly at the present juncture as the global recovery seems at risk. Hopefully this is all part of a necessary learning process. It is neither policy coordination nor true multilateral surveillance yet, but it is a step in the right direction. While it is still too soon to say whether the G20 can become an effective vehicle for steering the governance of the IMS, real progress will depend on whether the IMF is allowed to play a central role in the governance of the IMS. – One area where important improvements could be achieved is IMF surveillance. The systemic importance of financial sector issues and the existence of cross-border policy spillovers have highlighted the need to BIS central bankers’ speeches ensure: (a) greater interaction between bilateral and multilateral surveillance, and (b) greater focus on the financial sector. Some progress has already been made on these fronts, but there are limits to what can be realistically achieved on the basis of the existing legal foundations of Fund surveillance. – 5. One option would be a modification of the IMF Articles of Agreement – envisaging stronger obligations on countries’ domestic policies. A less ambitious option would be a new Board Decision on “Multilateral Surveillance”. Concluding remarks The world economy is still in the midst of the most severe financial crisis of the last 80 years but the reform process of the international monetary and financial system is stalling. In Washington at the IMF meetings two weeks ago, it was clearly visible that dealing with the worsening outlook of economic activity in the major industrial countries would take precedence over the reform agenda of the G20. This is a serious mistake if one considers the origin of the crisis. Since the beginning of the third millennium there has been a constant erosion of the creditworthiness of issuers of supposedly “safe” assets, be they the shares of dotcom companies in Wall Street, the subprime mortgages marketed with the unforgivable AAA blessing of rating agencies or the bonds issued by major financial institutions like Lehman Brothers. This erosion of trust is now creeping into the supposedly risk-free world of sovereign debt. The history of the international monetary system can be interpreted as the endless search for safe assets, safe from the erosion of value and the debasement of the currency that can derive from the misguided actions of monarchs, elected governments, parliaments and central banks. Gold was initially considered the safest asset as it was nobody’s liability, but then the relative shortage of gold led to the creation of the gold-dollar standard, where the safety of dollar-denominated assets was indirectly guaranteed by the link of the dollar to gold. When that link was severed, the world de facto delegated to financial markets the task of determining which assets are to be considered safe and which not. The problem with this arrangement is that markets are fickle and they can oscillate between one extreme, where all assets are safe, even junk bonds, Greek bonds, or Depfa bonds, and the opposite extreme, where there are virtually no safe assets, except a happy few, where every investor would like to place his or her money, irrespective of the yield. The age of financial globalisation has brought us to the verge of this second extreme. The extraordinary growth of financial activity has far outstripped the growth of real economies, leading to the accumulation of financial assets that are largely the liabilities – i.e. the debts – of countries, banks, corporations. The markets are telling us now that this process has gone too far and that a “deleveraging” – i.e. a reduction of the indebtedness – is now required by all debtors, public and private. The world economy is, in other words, confronted with a “global Triffin dilemma” in which the excessive indebtedness of the issuers of financial assets is now affecting the value of the assets themselves; of all assets, not just of reserve currencies, as in the early Triffin dilemma. But, how is it possible to carry out this huge process of deleveraging in an orderly manner and without further destabilising the world economy? The obvious answer is that it may take time and in any case a longer period of time than financial markets, suddenly become aware of the unsustainability of the situation, seem willing to concede. At the same time, financial market participants should be aware of the BIS central bankers’ speeches simple fact if they want to cash in all their financial assets, at once, this will result in the immediate bankruptcy of all debtors, be they private or public. I do believe that both creditors and debtors have a strong interest in the preservation of an open financial system, well regulated but free from protectionist restrictions. Thus, it should be possible to agree on some sort of a “truce”, whereby market participants grant the time required for an orderly deleveraging, in return for a credible commitment by national governments to pursue stability-oriented macroeconomic policies at home and to carry out a sensible reform of the current international monetary system. Such truce can only be enforced in the G20, which its leaders have elected to be the “premier forum for international economic cooperation”. A credible reform agenda should include: a strong multilateral surveillance procedure managed by the IMF and designed to adjust global payments imbalances and to contain the impact of the cross-border policy spillovers on the financial system; the implementation of the financial regulation reform elaborated by the Financial Stability Board to strengthen the resilience of banks and financial intermediaries and to discourage excessive risk taking; the implementation of the WTO’s Doha Development Agenda to preserve an open, multilateral and rule-based trading system; the commitment to establish a new multilateral reserve asset – hopefully with a more appealing name than the SDR – to become the “safe asset” that financial markets demand and that could be the anchor and the standard of a more stable international monetary system. Is this agenda “politically acceptable” to the G20 leaders? Probably not, but it may become soon the only available alternative to the present slow-moving, incremental approach to reform, if they want to prevent more serious troubles for the world monetary and financial system and for the world economy. BIS central bankers’ speeches | bank of italy | 2,011 | 10 |
Address by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the opening of the cultural days of the European Central Bank - Italy 2011, European Central Bank, Frankfurt am Main, 19 October 2011. | Mario Draghi: Opening of the cultural days of the European Central Bank – Italy 2011 Address by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the opening of the cultural days of the European Central Bank – Italy 2011, European Central Bank, Frankfurt am Main, 19 October 2011. * * * Madam Mayor, Mr. President, Ministers, my esteemed central bank colleagues, Ladies and Gentlemen, For me it is a privilege and an honour to inaugurate this event, together with Lord Mayor Petra Roth and President Jean-Claude Trichet, in the magnificent setting of the Alte Oper, which traditionally hosts the culmination of the European Central Bank’s Cultural Days. The Cultural Days, dedicated this year to Italy, are opening just days before the end of my term as Governor of the Bank of Italy and the beginning of my new position at the head of the ECB. This means that I will have the pleasure of being here in Frankfurt more often. This year’s edition of the Cultural Days is also distinguished by the fact that it coincides with the 150th anniversary of Italian national unity. At home, countless initiatives have retraced and commemorated the events that marked our history as a nation. Exalting Italy’s social and cultural roots is essential, because a country ignorant of its past is a country without a future. I am thoroughly convinced that our common European identity must be founded first of all upon common knowledge of the history and the traditions of the countries that make up the Union. The Cultural Days serve this purpose, stimulating reflections on our shared roots. They offer an opportunity to become familiar with the cultural heritage of the nations of Europe, to appreciate their fruitful differences, to comprehend their similarities, to grasp the full sense of our common Europe. Culture is fundamental to making the European Union a living reality. The diverse forms in which it is expressed, crossing borders, create channels for mutual understanding and forge a common feeling of belonging, over and above origin or language. We are now at the ninth edition of the Days, and certainly one of the reasons for the growing success of the initiative is the enthusiastic participation of the Frankfurt public, the primary audience. Let me thank you straight off for your attention to this dialogue. This year, there is perhaps an additional reason to spark the city’s interest: Frankfurt is the city of Goethe, the “universal” man of the Enlightenment whose Italienische Reise was an essential bridge between the culture of Germany and that of the Land wo die Zitronen blühen. The programme for these Days revisits our cultural heritage, our artistic and historical legacy, but it also reflects the culture and cultural activities of present-day Italy. Classical music is the centrepiece of the opening and closing concerts as well as the charity event, but there will also be presentations of contemporary Italian music. The Italian film days are entirely given over to contemporary directors and will offer the opportunity to reflect on the ways in which the traditional Italian family model has changed. In literature, the themes range from the deeper meaning of cultural identity to the role of women in the Risorgimento. This evening the Orchestra Mozart will perform the opening concert under the baton of Claudio Abbado. The Maestro’s career, his essential embodiment of the universal language of music, certainly needs no presentation. I cannot even begin to sum up the course of his art. Let me merely recall that he has conducted some of the world’s greatest orchestras: the Berliner Philarmoniker, the Wiener Philarmoniker, La Scala. Constantly engaged with social problems and active in promoting the artistic growth and careers of young musicians, Claudio Abbado has founded a series of orchestras for young instrumentalists of artistic excellence, including notably the Chamber Orchestra of Europe and the Orchestra Mozart, which came BIS central bankers’ speeches into being in Bologna. Both draw their players from a vast range of different countries, talented young musicians playing alongside established soloists. The Orchestra Mozart owes its name to the role that the city of Bologna played in Mozart’s development. It was with the Philharmonic Academy of Bologna – one of the centres of European cultural life – that Mozart, at the age of fourteen, took his diploma as “maestro compositore” on the 9th of October 1770. Music as solidarity, music as social life, music as at once expression of and factor in personal and cultural growth. These are the values that Claudio Abbado and all these young musicians have brought with them to the Orchestra Mozart, from the very start. Now, it is my pleasure to leave you to the sublime art of Gioacchino Rossini. Claudio Abbado conducts the Orchestra Mozart in the Overture to the Barber of Seville. BIS central bankers’ speeches | bank of italy | 2,011 | 10 |
Address by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the 87th World Savings Day, organized by the Association of Italian Savings Banks, Rome, 26 October 2011. | Mario Draghi: 2011 World Savings Day Address by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the Financial Stability Board, at the 87th World Savings Day, organized by the Association of Italian Savings Banks, Rome, 26 October 2011. * * * The crisis Economic activity in the euro area is expanding at a very modest pace, curbed by the slowdown in world demand, the fall in the confidence of firms and households, and the adverse effects on financial conditions of the strains in some sovereign debt markets. The risk of a further deterioration of the growth outlook is significant, in a context marked by pronounced uncertainty. The worsening of the crisis is a world and a European phenomenon, but Italy’s particular vulnerability has domestic roots: the large public debt, the doubts about the prospects for the growth of our economy, the hesitancy and delay with which steps to correct imbalances have been taken and measures to foster growth adopted. After declining in August, the gross yield on ten-year BTPs has returned to a very high level (more than 5.9 per cent yesterday). After six months of virtual stagnation, in the second quarter of this year Italy’s GDP began to grow again, but at a very modest pace. Although they continue to sustain economic activity, exports have been affected by the less vigorous growth in world demand. In their responses to surveys, firms report a worsening of their short-term outlook and a deterioration in their assessment of investment conditions. Domestic demand is weighed down by the weak trend in households’ disposable income, the slow recovery in employment, and the uncertainty about the economy’s prospects. The leading forecasters have reduced their expectations for growth next year; according to the International Monetary Fund, it will barely be positive. The Eurosystem is preventing, with its use of non-standard measures, the malfunctioning of the money and financial markets from obstructing the monetary transmission mechanism. With the provision of liquidity and the allotment modes used for refinancing operations, we are continuing to ensure that banks are not constrained on the liquidity side. We have announced a programme for the purchase of covered bonds. All the non-standard measures adopted in response to the financial strains are, by their nature, temporary. It remains essential to ensure price stability, anchoring inflation expectations in the euro area in line with the objective keeping inflation below, but close to, 2 per cent over the medium term. The interventions prevent the imbalances from worsening; on their own they cannot overcome the underlying causes. At European level there is an urgent need for a governance in which budgetary discipline and solidarity are mutually supportive; there is also an immediate need to implement the instruments of financial support for managing the crisis. But without a decisive and lasting response from appropriate domestic policies that, by promoting growth, remove the imbalances in the public finances, the first objective is unattainable, the second a palliative. The work begun with the first report of the Financial Stability Board in April 2008 has proceeded to good effect. Much has been done, both in implementing it and in drawing up new regulations. It is now necessary to continue with the transposition of the new rules into national legal systems. International coordination has been a key factor in imparting impetus to the reform of international finance; it remains crucial to its implementation. The contribution of the G20 leaders has been fundamental. To crown the process, the Financial Stability Board will submit a report to the next G20 summit in Cannes in November with specific recommendations regarding systemically BIS central bankers’ speeches important financial institutions, the limits to be imposed on the shadow banking system, and the reduction of the systemic risk associated with OTC derivatives business. The Italian banks Italy’s banks have to face the impact of sovereign risk on their funding, on the value of the collateral they provide for refinancing, and on their capital market. But our banks’ exposure to Greece, Ireland, Portugal and Spain is modest, amounting to about 1 per cent of total system assets. Their investment in Italian government securities is substantial. Although the banks’ short-term liquidity position continues to be in balance as a whole, it is affected by the persistence of strains, particularly on the wholesale markets, where fundraising has slowed markedly since the summer. The Bank of Italy continues to ask banks to maintain balanced liquidity positions; these positions undergo careful monitoring at weekly intervals by the Bank’s supervisory area. Though diminishing, the rate of growth in lending to both households and firms remained higher in August than the rates for the euro area. In September the three-month growth came to 3.9 per cent on an annualized basis. However, surveys of firms find a tightening of lending standards and growing difficulty in obtaining credit. The bank lending survey conducted by the Eurosystem also finds signs of a tightening of supply conditions by Italian banks, limited for now to requests for higher interest rates. Strong capital bases enable banks to cope with the cyclical worsening, and to contain the cost of fund-raising on the markets. On more than one occasion we have insisted that the banks should carry out capital increases. The response has been prompt so far and we trust it will continue to be so in the future. At European level, the largest banks are expected to equip themselves with adequate buffers of high-quality capital by the middle of next year. The amount is determined for each bank taking its exposure to sovereign risk into account. The request for temporarily higher capital ratios is necessary in order to address investors’ current worries, with benefits for banks’ funding on the wholesale markets. Our banks are up to this new challenge. We are fully confident that, as in the past, the banking foundations will shoulder their share of responsibility. If necessary, adequate backstops will be identified and put into operation in a timely manner. The difficulties that the Italian banking system finds itself facing today have origins that lie beyond it. In the longer term, the problems can be solved at the root only by increasing the growth potential of the Italian economy as a whole and acting on the sustainability of the public finances. The September budgetary package needs to be implemented completely and swiftly, in particular by rapidly setting up and carrying out the envisaged public expenditure revision. Savings and young people Historically, the capacity to save has always been a resource for the Italian economy. Last year Italian households’ net wealth was equal to eight times their disposable income, a value that is higher, sometimes considerably higher, than the ratios in the other leading advanced countries. For Italy, excluding government securities held directly or indirectly by households changes this ratio only marginally. Today’s accumulated wealth, however, is the product of the saving of the past. Unless it is fed by new inflows, it will soon be dented. BIS central bankers’ speeches The risks are not lacking. Since the turn of the century the propensity to save has fallen by about 4 percentage points, down to 12 per cent of income in 2010, almost 2 points below the euro-area average. The decline has been sharpest among the less affluent families, who have found it harder, in the face of stagnating disposable income, to reduce spending on essential goods and services. ACRI’s latest survey of Italians and savings found that only 13 per cent of those interviewed – the lowest value ever recorded – hope to save more next year. In part, the decline in the saving rate is due to the ageing of the population. It is accentuated not only by the diminished relative size of the younger generations but also by their diminished capacity to save. The deterioration of labour market entry-level wages, not offset by more rapid career advances, has helped to compress the propensity to save among households headed by young people. The share of young families with nil or negative saving has risen. Among those headed by persons under 35, it increased from 26 per cent in 2000 to 32 per cent in 2008. Heightened income instability also affects young people’s savings opportunities and decisions. In the absence of more equitable intergenerational redistribution of resources, young people today will have to contribute more heavily than in the past to the public finances. For a 35-year-old in 1990, the incidence of taxes and social security contributions on income, calculated on the basis of remaining life expectancy and net of the value of social benefits, was equal to approximately 20 per cent; for someone 35 years old today, it exceeds 25 per cent. A factor in this increase has been the excessively slow transition to the contributionsbased pension system. The older generations have been less severely affected. The recession has exacerbated economic difficulties above all for the young. The unemployment rate of Italians aged 15–24 rose by nearly 7.6 percentage points between 2007 and 2010 (nearly 3 points more than the average for the EU-15) and that of those aged 25–34 by 3.6 points; in the 35–64 age-group, the increase was 1.8 points. One source of difficulty has been the marked dualism of the labour market. Young people who lose their jobs are relatively unprotected by the existing income support programmes. Attenuating the segmentation that now exists in the labour market and making income protection programmes more universal, as well as more effective and rigorous, would help equalize employment opportunities and income prospects, which are now heavily tilted in favour of the older generations. Contracts providing for protection that builds over time and the introduction of a modern system of unemployment benefits would make the labour market more fluid and efficient, as well as more equitable. Well-designed measures along these lines could also help stimulate labour market participation. In addition, this would benefit the propensity for forms of saving more oriented to the long term, which in turn, suitably channeled, could facilitate the birth and growth of new enterprises with greater potential for innovation. Reforms for growth Policies that stimulate growth and economic dynamism expand the opportunities for young people. At the same time, the measures required to impart renewed impulse to growth will hinge on young people, easing the constraints on their contribution. Removing the barriers to economic activity by lowering the cost of forming and running new enterprises will increase economic participation by the younger generation. New enterprises – in which economists place their hopes both for their high potential for innovation and for their capacity to stimulate efficiency in others – are mostly in the hands of entrepreneurs under the age of 40. And they tend to employ younger workers. But they will be more dynamic and competitive only if the work force has a suitably high level of educational attainment, which is an essential factor for growth in the “knowledge-based economy.” BIS central bankers’ speeches In the short term, macroeconomic policy measures can help to support growth. The composition of fiscal revenue can be modified, shifting the burden from levies on labour and productive activity to taxes on property and consumption. But above all the durable achievement of faster sustainable growth requires the structural reforms invoked for so long, broadly endorsed but as yet unimplemented: heightening competition in the product markets, especially in the service sector; creating a more enterprise-friendly administrative and regulatory environment; stimulating the accumulation of physical and human capital; and raising the levels of labour market participation. Such measures imply the substantially recasting the priorities and overhauling the modus operandi of public policy and administration. They must not be allowed, under the pressure of vested interests, to leave particular areas untouched. Properly designed and communicated, these measures can have an immediate propulsive impact, enhancing business confidence and expectations, increasing the propensity to invest, and narrowing the spread on Italy’s public debt. This is my last official speech as Governor of the Bank of Italy. I end my term amidst a confused and dramatic situation at home and abroad on both the political and the economic fronts. When I took the floor in this venue six years ago, incidentally with a speech on growth, the situation was very different. Its apparent tranquility, the generally indulgent, indeed admiring, attitude towards finance as the engine of growth concealed the seeds of the future disaster. Italy bore none of the blame for the crisis. But because of never redressed structural weaknesses Italy was overwhelmed by it, penalized more than others, to the point that today, owing to its slowness in overcoming its own crisis, Italy itself has become a cause of general crisis. Nevertheless, the gravity and complexity of the situation must not make us forget our strengths. The first of these is our Head of State, whom I wish to thank both personally as a citizen and institutionally on behalf of the Bank of Italy. He is a beacon, an inspiration, an example. The second strength comes from looking back on what has been accomplished. In these six years we have done a great deal. The Bank of Italy has made outstanding contributions at domestic and international level to the efforts to cope with the crisis, to revamping supervisory action, to the design and management of European monetary policy, to the formulation and implementation of the reform of European and global regulation. The autonomy of the Bank of Italy has been essential for all this. The Bank’s autonomy is not an end in itself. It is an essential element of the way in which the Bank exercises the powers and performs the duties defined in its Statute, the Italian Constitution and the European Treaty. In exercising these powers, the Bank is called upon to safeguard the common good, for it is always perceived as impartial and not subject to external controls or interventions. The General Council does not represent private interests; it does not intervene in matters for which the Bank or its top management is alone responsible; it oversees the Bank’s administration, its management and its choices. I now take leave of the Bank with a peaceful mind, with, I believe, your warm feelings that will accompany me to Frankfurt. The new governor epitomizes all the best that the Bank has produced in its tradition of training authentic central bankers. The Bank’s organization is sound and strong. But you too – Italy’s banking foundations and banking system – have done much in these years to cope with the crisis by increasing resources, making sacrifices, changing operating rules, and aligning incentives with results, and you deserve ample credit for this. BIS central bankers’ speeches It is, then, from the strength of some of our institutions, from the awareness that we have succeeded in accomplishing things that seemed impossible, that we draw courage, security, the belief we will succeed. But we are experiencing a historical discontinuity. We are moving towards a new European pact, towards a shared management of the underlying problems of our economies in which each is called on to shoulder more responsibility in serving the common good. Although the forms may be mortifying, the substance of the problems to be solved does not depend on the person who enunciates them. It is in the interest of the individual member states to recognize this substance, to recognize the ways to go forward – and without hoping in others – to trust in themselves, their own strength, their own history – to save themselves in Europe. This is the fundamental lesson of the crisis: to build the future in Europe together. Only by doing so will we be able to remake Italy. BIS central bankers’ speeches | bank of italy | 2,011 | 10 |
Testimony of Mr Ignazio Visco, Governor of the Bank of Italy, at the Joint Session of the Fifth Committees of the Italian Senate and Chamber of Deputies, Rome, 9 December 2011. | Ignazio Visco: Fact-finding with regard to the decree law containing urgent measures for growth, equity and the consolidation of the public finances Testimony of Mr Ignazio Visco, Governor of the Bank of Italy, at the Joint Session of the Fifth Committees of the Italian Senate and Chamber of Deputies, Rome, 9 December 2011. * * * The sovereign debt crises in the euro area call for robust, rapid and courageous responses at the national, European and global levels. In Italy tensions have worsened since the summer, with alarming repercussions on the spread between Italian and German government bonds. The Government’s decree law which supplements the measures passed in July and August, is a necessary and urgent step to re-establish the creditworthiness of the Italian state and avoid extremely serious and lasting consequences for the real economy. The measures, which aim to achieve budgetary balance in 2013, determine an adjustment on the order of €20 billion annually for each of the next three years. Taking the measures adopted in the summer into account, the adjustment in 2013 is equal to €76 billion. About two thirds of the new measures are on the revenue side, pushing the ratio of taxes and social security contributions to GDP up to around 45 per cent. The procedures for implementing the safeguard clause linked to the enabling law for tax and welfare reform are defined. The measures on government spending mostly affect pensions, completing the long process of reform serving to bring our system into line with the changed socio-demographic and economic growth prospects. Partly as a result of the adjustments made in the summer, primary spending falls in nominal terms. The only way to increase its efficiency is by systematically evaluating individual spending items. Firm action against tax evasion remains a priority. The tax base brought to light and the resources released following the rationalization of spending, will make it possible to achieve the reduction in the tax burden needed to give greater stimulus to enterprise and employment. The budgetary provisions contained in the decree will cause GDP to decline by an estimated half a percentage point in the next two years. The impact could be largely offset if the fall in the yield on Italian 10-year bonds seen in the days immediately following the promulgation of the decree were to be confirmed and extend across the entire range of maturities. The effort to ensure a return to higher growth rates, an improvement in firms’ competitiveness and the creation of more jobs must be intensified, by rapidly implementing effective measures supplementing those already defined in the Government decree, in an allembracing framework to provide lasting reassurance to those who have invested and are investing in our State, in our country. 1. The decree law of 6 December 2011 The decree law reduces net borrowing by €20.2 billion in 2012, €21.3 billion in 2013 and €21.4 billion in 2014. In relation to GDP, the adjustment is equal to 1.3 percentage points in each year. The measures are in addition to those approved during the summer and those introduced by the 2012 Stability Law, which provided for a reduction in the budget deficit of €28.6 billion in 2012, €54.4 billion in 2013 and €59.9 billion in 2014. In total, the measures BIS central bankers’ speeches should reduce net borrowing by about 3 percentage points of GDP in 2012 and by more than 4.5 points on average in the two years 2013–14.1 A large part of the correction involves revenue, with effects that decline over the three-year period (from €17.9 billion in 2012 to €12.1 billion in 2014). On the spending side the adjustment, which rises from €2.3 billion in 2012 to €9.3 billion in 2014, is mainly due to the measures relating to pensions. Over the three years, the measures generate resources totaling €32.3 billion in 2012, €35.1 billion in 2013 and €37.1 billion in 2014. In part these amounts are used for tax relief (€3.6, €7.3 and €8.4 billion respectively), for extra expenditure (€4.6 billion in 2012 and €3.6 billion in 2013 and 2014) and to reduce the resources to be raised with the implementation of the enabling law on tax and welfare reform (€4.0 billion in 2012, €2.9 billion in 2013 and €3.6 billion in 2014). In particular, the decree eliminates the doubts about the effects of the enabling law (€4.0 billion in 2012, €16 billion in 2013 and €20 billion in 2014) and the procedures for implementing the relative safeguard clause. Part of the resources in relation to 2012 (€3.3 billion of the aforementioned €4.0 billion) derives from the increase of two percentage points in the reduced and standard VAT rates (to 12 per cent and 23 per cent respectively) from next October. The safeguard clause has been redefined: the previously mentioned increase in VAT rates will become permanent and will be followed by a further increase in the rates of half a percentage point in 2014 if provisions have not come into force by September 2012 to implement the enabling law or if modifications are not made to the tax exemption and subsidy systems producing €13.1 billion of additional revenue in 2013 and €16.4 billion in 2014. With the aim of encouraging competition, the decree law also provides for liberalization measures in some sectors (retail outlets, pharmacies and transport), measures to increase the powers of the Antitrust Authority (AGCM), and others to simplify the procedures and reduce the time taken to build infrastructure. 2. An overall evaluation The sharp deterioration in growth prospects in recent months and the drastic worsening of state funding conditions mean that last summer’s corrective measures, although important, are now insufficient to respect the commitment made at European level to achieve a balanced budget in 2013. There was a further increase in the spread between Italian and German 10-year bonds which, in the second week of November, peaked at 575 basis points. Additional measures were therefore urgently needed to consolidate the budget and even more resolute action to address the structural problems of Italy’s economy. The packages passed in July, August and December show Italy’s determination to achieve a permanent adjustment of its public finances; they make it possible to achieve the objectives announced: a balanced budget in 2013 remains the fixed objective for fiscal policy. The size of the austerity package presented on 6 December is intended to reassure the markets; it is larger than what would have been necessary in the less troubled times of a few months ago. The measures have effects which are permanent and, in particular with reference to pensions, increasing over time. The contribution of one-off measures to the adjustment is small. Pension reform, by setting more stringent requirements for retirement, immediately strengthens the financial sustainability of the pension system. The measures, whose costs in For a brief description of the main provisions of the decree, see the Appendix. BIS central bankers’ speeches terms of reducing spending power and frustrating individual expectations cannot be concealed, virtually complete the long phase of adjusting the system to the changed sociodemographic situation and economic growth prospects. The extension of the contributionsbased system to all workers reduces disparity in treatment and links the benefits received more closely to the contributions paid in, thereby reducing distortions in the supply of labour. The challenge now is to provide older workers with satisfactory job opportunities and offer younger ones regular careers that produce sufficient cumulative pension contributions. It is essential, therefore, to adapt the labour market rules, revise unemployment and welfare benefits, and reinforce private pension funds. Given the need to lower net borrowing very quickly, the correction relies largely on revenue increases. This will result in a further rise in total taxes and social contributions to about 45 per cent of GDP, very high by both historical and international standards. The composition of tax revenue has been somewhat modified in order to sustain economic activity and enhance competitiveness. Some tax relief is granted to firms for the purpose of strengthening their capital bases and reducing labour costs, thus helping to boost employment. Above all, levies on assets and consumption are increased. The stepped-up taxation of real estate is consistent with government decentralization, because it tightens the direct link between taxes paid and public services. Instituting ordinary forms of taxation of total wealth, as in other countries and also with a view to reducing income tax, requires the preparation of adequate means of acquiring information. A contribution to achieving the public finance targets is to come from a strict curb on primary expenditure, which should be €4 billion less in 2013 than in 2010, requiring a significant reduction in real terms. Only if appropriate mechanisms for detailed, item-by-item analysis of spending and accurate indicators of the efficiency of public structures (offices, schools, hospitals and courts) are put in place can the adequacy of the appropriation for each item be assessed independently of the amount of past spending. Resolute action along these lines while proceeding with cost containment and reduction for public agencies and governmental institutions can help in the medium run to free resources for reducing the tax burden. On 30 November the Chamber of Deputies approved on first reading a constitutional amendment requiring a balanced general government budget. A rule of this sort can help to maintain the budgetary balance set to be reached in 2013. In the past, the accomplishments of sharp fiscal adjustments have been eroded in the years that followed. Some measures are designed for more effective action against tax evasion, which is Italy’s most serious obstacle to the fair sharing of the fiscal burden. It is essential to continue along these lines, in particular by enhancing the effectiveness of administrative action. Among other things, shrinking the area of tax evasion facilitates the design of programmes for lowincome citizens, for which it is essential to have reliable information on the real economic situation of households. Looking ahead, this could make it possible to ease the concentration of the tax burden and step up incentives for labour and enterprise. The tax wedge on labour income in Italy is 5.5 percentage points higher than the euro-area average. The official tax rate on corporate income, even excluding the regional tax on productive activity, is more than 4 points higher. In the medium term significant tax cuts must be accompanied by curbs on spending. If gains on this front were made more rapidly, there could be an attenuation of the rise in VAT rates provided for in case of failure to implement the tax and welfare enabling act, in particular the projected rise on items currently subject to the reduced rate of 10 per cent, which would have the most strongly regressive effect on income distribution. With a view to stimulating a return to faster economic growth, the structural measures contained in the decree remove some constraints and restrictions on competition and business activity and will simplify and accelerate the realization of infrastructure projects. BIS central bankers’ speeches The liberalization of pharmacies, retailing and transport resumes the reform processes initiated in the second half of the last decade. Powers of regulation and monitoring are assigned to independent authorities (which will incorporate today’s existing agencies) in the sectors of water management and postal services. This is a course already given significant impulse by the measures taken during the summer concerning professional services and local public services; it must be resolutely pursued with effective implementation of the measures already enacted. Further reforms will be needed to make the set of structural actions consistent and comprehensive, with priorities being established and account taken of Italy’s standing in the most common international rankings, in order to improve the perception of the country system by foreign investors as well. The Government’s decision not to intervene immediately, in the decree, on issues involving employment relations and unemployment and welfare benefits will make it possible to hear the views of labour and employer organizations. Nevertheless, action on these matters is urgent, in particular to provide for easier and more secure access to the job market for young people and ensure that they can achieve economic advancement that is not ephemeral. Welfare reform should form part of an overall vision of social protection guided by the principle of universality. This means, among other things, combining the income support programmes for workers who lose their jobs with active policies of retraining and occupational reintegration. 3. The outlook Over the past few months the outlook for growth in the euro area has deteriorated steadily. Cyclical indicators point to a further slackening of economic activity in the fourth quarter from the already low rates of growth registered in the central part of the year. The Eurosystem projections released yesterday, which are basically in line with the latest estimates of the main international organizations and leading private forecasters, are for modest GDP growth in 2012, held back on the one hand by the slowdown in world trade and less expansive budgetary policies and on the other by the sovereign debt strains and the heightened risk aversion of economic agents. Against this backdrop, economic activity in Italy is subject to additional factors of fragility, connected above all with the large public debt; these will be reflected in a contraction of GDP in 2012 and very slow growth in 2013. The worsening of the growth outlook since last summer’s forecasts reflects the measures for the adjustment of the public finances enacted in recent months and the exceptional widening of the spread vis-à-vis German government bonds, which is being passed through to the cost of finance to the private sector and the spending plans of households and firms, thereby diminishing the domestic component of aggregate demand. A further tightening of credit supply terms could follow if banks continue to encounter funding difficulties on wholesale markets. The macroeconomic picture for the next few quarters is marked by extraordinarily great uncertainty, provoked mainly by the euro-area public debt crisis. If the yield spreads on government bonds were to remain very wide for a long time, this would further undermine the outlook for growth and constitute an obstacle to the planned adjustment of the public finances. Restoring confidence is essential to sustain growth. Other things being equal, the budget measures contained in the decree, which are indispensable to avert still worse scenarios, will inevitably have a negative impact on economic activity. Going by the historical pattern, the impact of the additional measures on GDP can be estimated as amounting to about half a percentage point over the next two years. However, this restrictive effect may be countered by the positive effects of increased confidence in Italy’s ability to honour its debt and improving medium-term prospects for BIS central bankers’ speeches economic growth. A reduction in the cost of finance to the public sector and to households and firms could favour growth in the immediate. The initial impact of the Government’s measures is indicative: the day after the announcement of the package the yield on ten-year bonds came down by 80 basis points. A reduction of that amount, if it were permanent and extended to the entire yield curve, would largely compensate for the restrictive effects of the budget package. The Government has also introduced measures to sustain economic growth, such as a tax allowance for corporate equity, the deductibility of the portion of IRAP relating to labour costs, provisions to foster competition and measures for infrastructure investment. Action must proceed with wide-ranging measures that gradually bring the economy up to a higher and better balanced growth path. It is crucial to establish a clear and credible comprehensive framework within which to place individual measures. This programme must comprise both the measures already specified and those to be designed starting today. It must apply both to the measures that can be taken in the short term and to those that will require more time. A comprehensive approach to the design of pro-growth measures can bolster confidence in the prospects for our economy, with beneficial effects on investment and the cost of the public debt. The measures – as we know – must aim to reduce administrative costs and the length of judicial proceedings; improve the efficacy of regulation and stimulate competition; raise the quality of public services and obtain better terms for infrastructure projects, including by means of resolute action on the legality front; they must also remove the obstacles to the growth of firms’ size, enhance the formation of human capital, facilitate innovation and improve the working of the labour market. BIS central bankers’ speeches Appendix: Summary of the decree law’s main provisions A.1 Measures that increase revenue The decree produces increased revenue of €25.5 billion in 2012, €24.6 billion in 2013 and €24.1 billion in 2014. Most of the increase comes from the taxation of real estate and excise duties. Other measures increase the taxation of assets other than real estate. Further provisions are designed to strengthen the fight against tax evasion. Taxation of real estate. – The decree brings forward the entry into force of the own municipal tax (IMP), instituted by the legislative decree on municipal federalism, from 2014 to 2012 and modifies the related tax base significantly. The latter now includes first homes and is calculated by applying higher adjustment factors to upwardly revised cadastral income than those previously in force for the municipal property tax (ICI), especially for residential buildings. As already provided by the March legislative decree for the implementation of municipal federalism, the new tax supersedes ICI and personal income tax (plus the related surtaxes) on imputed income from non-leased property (second homes). The basic IMP rate is confirmed at 0.76 per cent, except for first homes and rural buildings for instrumental use, to which reduced rates of respectively 0.4 and 0.2 per cent apply. For first homes there is a tax credit of €200. Municipalities may raise or lower the basic rate by 0.3 percentage points and the rate on first homes by 0.2 points. They may also raise the tax credit up to the amount of the tax due, but in this case they may not increase the ordinary rate for houses available for use by the owner. The central government is reserved half of the receipts from buildings other than first homes and rural buildings for instrumental use, determined by applying the basic rate; that share is officially estimated at €9 billion. The increase in municipal revenues deriving from the introduction of IMP (€2 billion according to the official estimates) is offset by a reduction in central government transfers to municipalities. Going forward, the revision of cadastral values needs to be accelerated. According to the Revenue Agency’s latest estimates, the overall market value of the stock of housing is much higher than its taxable value; the discrepancy increases with the real-estate wealth of the owners; it also varies greatly according to the exact urban location and age of the building. Updating cadastral values would permit a rebalancing of these distributive aspects while keeping receipts unchanged. Regional personal income surtax. – The decree law has raised the basic rate of the regional personal income surtax from 0.93 to 1.23 per cent with effect from the 2011 tax year. According to the official estimates, this will produce additional revenue of €2.2 billion from 2012 onwards, offset in regional budgets by the reduction in central government transfers to finance health care. Excise duties. – The decree provides for an immediate increase in the excise duties on petrol, diesel oil, LPG and methane for use as fuels, with the additional revenue estimated at €5.9 billion per year (including the secondary effects on value-added tax); the receipts from the above excise duties are put at more than €30 billion. The impact of these increases on consumer price inflation in 2012 will be on the order of 0.2 percentage points. Taxation of assets other than real estate. – The decree law rationalizes the measure introduced with the first budget correction during the summer regarding the stamp duty on securities accounts by extending the tax to apply to financial products not held in securities accounts, except for pension funds and health funds. The tax levied as a fixed amount for different securities value brackets is replaced by a proportional levy of 0.1 per cent in 2012 BIS central bankers’ speeches and 0.15 per cent thereafter. A minimum of €34.20 and maximum of €1,200 are set for the amount of tax payable. Lastly, where possible the securities are to be calculated at market rather than face value. According to the official estimates, the additional revenue with respect to the stamp duty enacted during the summer should be €1 billion a year in the next two years and €0.5 billion a year thereafter. The decree also establishes a one-off 1.5 per cent levy on assets repatriated or disclosed under the favourable tax measures introduced in 2001 and 2009, with the proceeds estimated at €1.1 billion in 2012 and in 2013. A series of provisions increase the taxes on the ownership and use of luxury goods such as large cars, boats and airplanes. They will yield additional revenue of €0.4 billion. Measures against tax evasion. – The decree attacks tax evasion by reducing the ceiling for cash transactions from €2,500 to €1,000. A further reduction would be desirable and should be accompanied by a reduction in the costs of using electronic money. In addition, to foster the emergence of tax bases, some benefits are introduced from 2013 onwards for natural persons, partnerships and taxpayers subject to sector studies adopting transparent courses of conduct in tax matters. Checks conducted by the Revenue Agency and the Finance Police on the basis of specific analyses of the risk of evasion are to be strengthened. Accordingly, from 2012 onwards banks and other financial intermediaries will be required to transmit the data on financial movements on customers’ accounts to the authorities for the purpose of tax audits. By significantly expanding the database available to the tax authorities, the measure will facilitate the exercise of other powers such as the use of presumptive income tables and audits of persons not in conformity with sector studies. Further, INPS will be required to inform the tax authorities of the social and welfare services and benefits provided to taxpayers, thereby making it easier to check the accuracy of declared incomes. To foster the modernization and efficiency of payment instruments and reduce the financial and administrative costs deriving from cash management, payments by general government in amounts greater than €500 are to be made by means of electronic instruments and cashless procedures. A.2 Tax reductions The austerity package entails revenue decreases of €7.6 billion in 2012, €10.2 billion in 2013 and €12.0 billion in 2014. Apart from the safeguard clause, the main measures introduce tax reliefs in favour of firms. Deductibility of the return on new equity. – Among the measures for growth, the decree law introduces an “aid to economic growth” modelled on the allowance for corporate equity, i.e. in the form of the deductibility of the normal return on equity, estimated by applying a notional return to new issues of equity. This mechanism makes for greater tax neutrality in the choices of corporate financing, fostering a reinforcement of Italian businesses’ capital structure. The facilitation applies to increases in equity capital with respect to the level at the end of the financial year in course on 31 December 2010. Given its incremental nature, the measure can couple moderate losses of revenue with powerful incentive effects and enable firms to undertake more innovative and potentially more productive and remunerative investment projects. Consequently it can foster the growth in size of Italian firms and impart impetus to new initiatives. The expected reduction in receipts amounts to €1.0 billion next year, €1.4 billion in 2013 and €2.9 billion in 2014. BIS central bankers’ speeches Deductibility of IRAP and reduction in labour costs. – The staff costs subject to the regional tax on productive activities (IRAP) are to be totally deductible from corporate income tax and personal income tax from 2012 onwards, with an estimated decrease in revenue of €1.5 billion in 2012, €1.9 billion in 2013 and €2.0 billion in 2014. Furthermore, the deduction from the IRAP tax base that firms can claim for each new female employee or each new employee under age 35 hired on a permanent contract is increased by €6,000. By reducing labour costs, these measures could have positive effects on firms’ competitiveness and the labour market participation of women and young people. In the case of an employee with gross earnings equal to the national accounts average for 2010, the new deductions for workers under 35 and for women constitute a benefit equivalent to 0.5 per cent of the cost of labour. A.3 Measures affecting expenditure Expenditure will be reduced mainly through intervention on pensions and transfers to local government. Measures will also be taken to contain the running costs of public agencies and institutional bodies. Pensions. – The decree law completely overhauls the rules on pensions. From 2012 the contributions-based method of calculating pensions will also apply on a pro-rata basis to people with over 18 years of contributions in 1995: this will reduce, albeit to a limited degree, the unequal treatment favouring this category (in fact, for everyone else the new method has been in use since 1995). From 2018 the adjustment of qualifying age and contribution requirements to life expectancy and the recalculation of the coefficients for converting the total amount of contributions into income will take place every two years, instead of every three. As far as old-age pensions are concerned, the alignment of the qualifying age for female workers in the private sector to that of other workers will be brought forward. The qualifying age will be 66 for everyone starting in 2018 (barring any increments due to changes in life expectancy). The quota system for long-service pensions is abolished. In order to claim such benefits the following requirements must be met: in 2012, 42 years and 1 month of contributions for men and 41 years and 1 month of contributions for women. If retirement is taken before the age of 62, a penalty is levied amounting to 2 per cent for each year up to that age. In addition, the qualifying age of 62 years and the qualifying contribution period are henceforth anchored to future changes in life expectancy. The system of “claim windows” is abolished and the qualifying age and contribution requirements are increased accordingly. This change does not alter the full retirement age, but it does simplify the regulations. For workers paying into the contribution system alone, i.e. those who entered the workplace on or after 1 January 1996, an element of flexibility is offered: they may claim their pension if they fulfil the following requirements: 63 years of age, 20 years of contributions, and a pension equal to at least 2.8 times the minimum state pension. In practice, it will be a long time before this rule is applied on a large scale. The qualifying age of 63 years will also take account of changes in life expectancy. The contribution rate for self-employed workers is increased (by 0.3 percentage points a year, to a maximum of 22 per cent). A solidarity contribution is introduced from 2012 to 2017, to be levied on contributions paid into and pensions paid out by the airline workers’ pension fund and other pension funds incorporated into the INPS employee workers’ pension fund (only if those pensions are more than five times the minimum). BIS central bankers’ speeches Last, the indexation of pensions amounting to more than twice the minimum (€937) is suspended in 2012 and 2013, thereby reducing net borrowing by €2.9 billion and €4.9 billion. This measure replaces the one included in the summer reform package. There is no change in the solidarity contribution applying to pensions of over €90,000 (equal to 5 per cent of the part from €90,000 to €150,000 and 10 per cent of the amount exceeding €150,000). Transfers to local government. – The austerity package includes a reduction of €2.8 billion in local government transfers starting in 2012: €0.9 billion less to the special-statute regions, €0.4 billion less to the provinces and €1.5 billion less to the municipalities. For the specialstatute regions the spending cuts are enacted through ad hoc coordination procedures and for the provinces and municipalities through reductions in transfers to the experimental “re-balancing” funds (for the redistribution of property taxes) and to the fiscal revenue equalization funds (as well as in fiscal transfers to such bodies in Sicily and Sardinia). Operating costs of some public agencies and institutional bodies. – Measures are introduced to reduce the operating costs of some public agencies. A few of the latter are abolished and their functions, and permanent staff, transferred to other bodies. The functions of INPDAP (National Pension Institute for General Government Employees) and ENPALS (National Pension and Healthcare Institute for the Entertainment Industry) are transferred to INPS. This measure is estimated to produce a saving of at least €20 million in 2012, €50 million in 2013 and €100 million from 2014, which will be devolved to the sinking fund for the redemption of government securities. The decree envisages a reduction in the number of independent administrative authorities. If the committee instituted under the July package with the objective of bringing the compensation of Italian elected offices into line with European averages has not completed its mandate by the end of 2011, the Government will introduce a measure of its own. The functioning of the provinces is to be overhauled by taking action on three levels: transferring functions to municipalities and regions (except for municipal policy guidance and coordination), reducing the number of councillors to a maximum of ten (appointed by the elected municipal bodies within the province), and eliminating the board of councillors, with the exception of the chairman. The measures should be finalized by 30 April 2012. More drastic measures to eliminate and reorganize local authorities may be introduced by laws of constitutional force. Economies of scale are exploited by adopting centralized management systems for calls to tender issued by municipalities with up to 5,000 inhabitants. Moreover, elected offices of local authorities not envisaged in the Constitution will not receive any compensation. Increases in expenditure. – The austerity package includes some measures that raise expenditure; the increase in spending is estimated at €4.6 billion in 2012 and €3.6 billion in 2013 and 2014. The budget funds for development and local transport are increased (by €1.8 billion each year for the next three years). In addition, peace missions are to receive new funding (€0.8 billion in 2012) and spending on road transport is expected to rise (by €1.1 billion each year) to offset the increase in costs resulting from higher fuel taxes. A.4 Other measures The impact on the budget of some of the measures included in the package is not quantified for reasons of caution. Above all, these are measures that regulate the allocation of part of the revenue from the sale of CO2 emission quotas to the sinking fund for the redemption of government securities. The fund is also allocated any revenue from projects envisaged under the package to enhance public real-estate assets at local level by setting up companies, consortiums or local property funds. Such projects are promoted by the State Property Office, which works with BIS central bankers’ speeches the public management agencies and can join the company or other body as partner, as well as select potential private sector participants. These measures are in line with the commitments entered into by the previous government. The austerity package also provides for lira coins, notes and banknotes still in circulation to lapse and for their value to be assigned to the sinking fund for the redemption of government securities. At the beginning of December, lira banknotes in circulation amounted to €1,272 million; after the adoption of the euro, the Treasury was assigned €837 million, of which €662 million represented an advance on the lire that would lapse on 28 February 2012 and €175 million represented lira banknotes lapsing in the interval; the remaining sum to be assigned to the Treasury should therefore be on the order of €600 million. A.5 Structural measures for growth Liberalizations. – The decree law provides for the liberalization of shop opening hours and days, extending the trial measures adopted in tourist locations and cities of art and culture, and introduces the principle of freedom of opening hours, excluding restrictions of any kind except for those safeguarding workers’ health and the environment. In order to promote competition in the pharmacy sector and lower the prices paid by consumers for pharmaceutical products, the decree proposes to expand the distribution channels of several kinds of drug (included in the “Fascia C” category) in municipalities with more than 15,000 inhabitants, and to allow discounts to be applied freely to the prices of all products sold in pharmacies and approved retail outlets. These measures go some way towards increasing competition in the system. The sector’s liberalization could be advanced by the adoption of measures allowing the number of pharmacies in Italy to be increased. In the rail, air and sea transport sector, which remains among those least exposed to competition, provision is made for the adoption of a set of measures, to be implemented via governmental regulations, designed to achieve full liberalization. A key element of the new sector regulations is the creation of an independent authority, whose proposed functions and powers respond to the need to ensure it can regulate the sector effectively. The liberalization measures should be extended to other sectors that are only moderately exposed to competition, such as urban mobility and postal services. Additional measures to foster competition. – The decree establishes important principles regarding the freedom of economic initiative and the limits and procedures of state regulation. Moreover, it abrogates, with immediate effect, a series of restrictions on engaging in economic activities. The abolition of the regulatory agency for postal services and the national agency that regulates and supervises water services, and the transfer of their functions to existing authorities, goes some way towards achieving more effective sector regulation insofar as it ensures greater independence of the regulator. Measures for industrial development. – The decree contains measures to support innovation and bolster policies facilitating firms’ access to credit. On the innovation side, it expands the range of investments that qualify for support under the Revolving Fund to Support Enterprises and Research Investment; in particular, it provides for the inclusion of industrial innovation projects, an area where Italy’s shortcomings are especially marked by European standards. Regarding access to credit, the Guarantee Fund for Small- and Medium-sized Enterprises is strengthened, first by being refinanced, and second, by modifying how it works, thereby attenuating the risks associated with the tighter lending standards businesses and banks anticipate in the coming months, and lessening the operational difficulties the Fund is experiencing owing to the large number of requests for guarantees received in recent years. These measures confirm the central role which this instrument has played in facilitating access to credit from the onset of the crisis. BIS central bankers’ speeches The implementation of infrastructure projects. – The decree contains several measures aimed at simplifying and speeding up the implementation of infrastructure projects. In particular, by strengthening the powers of the Ministry for Infrastructure and Transport, the criteria and procedures for identifying strategic works are rationalized and simplified, the approval procedure streamlined, and powers to verify the progress of works introduced. There are plans to encourage greater involvement by private capital in the realization of public works and to increase recourse to public-private partnerships. Measures are introduced to make tender procedures more efficient by centralizing orders and to facilitate the participation of small and medium-sized enterprises. Overall, the measures are consistent with the objectives of speeding up the procedures and achieving greater involvement of private capital in the implementation of infrastructure. However, the proper use of public-private partnerships requires safeguards to guarantee the clear and efficient allocation of risks and careful monitoring of projects’ day-to-day management. It is also important to ensure there are adequate technical skills at local government level to guarantee pursuit of the public interest. Interventions in the banking system. – The decree law includes measures to ease tensions in the banking system stemming from the sovereign debt crisis. Under one provision, Italian banks can benefit from a state guarantee for their liabilities at least until June 2012. The Italian government must intervene to enable banks to raise the funds needed to finance loans to firms and households. The procedures for benefiting from state guarantees are set out in accordance with the European Commission recommendations on the application of the rules on state aid to measures supporting banks in the context of the financial crisis. The measure has no effect on net borrowing or, until such time as the guarantee is executed, general government debt. To qualify, banks must meet requirements drawn up in a way that ensures the guarantee is provided only to financially sound intermediaries experiencing temporary liquidity problems. The decree specifies the liabilities that are covered by the guarantee, to prevent it from being extended to the entire stock of bank liabilities. BIS central bankers’ speeches TABLES AND FIGURES BIS central bankers' speeches Table 1. Table 2. Table 3. Main public finance indicators for general government General government revenue General government expenditure Table 4. Table 5. Table 6. General government consolidated accounts on a current legislation basis Table 8. Table 9. Table 10. General government borrowing requirement Effects on the general government consolidated accounts of the budgetary measures adopted in the summer and of those introduced in the 2012 Stability Law Effects on the general government consolidated accounts of the measures included in Decree Law 201/2011 Total effect on net borrowing of the recent budgetary packages Objectives for the public finances and the budgetary packages Minimum contribution and age requirements for retirement Figure 1. Figure 2. Figure 3. Figure 4. Figure 5. Figure 6. Net borrowing (+) and lending (-) in the euro-area countries in 2010 Gross public debt in the euro-area countries in 2010 Composition of general government revenue in the euro-area countries in 2010 Composition of general government expenditure in the euro-area countries in 2010 Twelve-month cumulative borrowing requirement State budget tax revenue Figure 7. 10-year government bond yield differentials with respect to Germany in 2009-11 10-year government bond yield differentials with respect to Germany in 2011 Average cost of the debt, average gross interest rate on BOTs, and gross yield on 10-year BTPs Table 7. Figure 8. Figure 9. BIS central bankers' speeches Table 1 Main public finance indicators for general government (as a percentage of GDP) Revenue 44.7 44.1 44.7 44.3 43.9 45.5 46.5 46.5 46.8 46.4 Expenditure 47.8 47.2 48.4 47.8 48.3 49.0 48.2 49.2 52.3 51.0 6.2 5.6 5.1 4.7 4.6 4.6 5.0 5.2 4.6 4.5 Primary surplus 3.1 2.5 1.5 1.2 0.2 1.2 3.4 2.5 -0.8 -0.1 Net borrowing 3.1 3.1 3.6 3.5 4.4 3.4 1.6 2.7 5.4 4.6 Borrowing requirement 4.6 2.9 2.9 3.6 5.0 4.0 1.7 3.1 5.6 4.3 Borrowing requirement net of privatization receipts 5.0 3.0 4.2 4.2 5.3 4.0 2.0 3.1 5.7 4.3 Debt 108.2 105.1 103.9 103.4 105.4 106.1 103.1 105.8 115.5 118.4 of which: interest payments Source: For the general government consolidated accounts, based on Istat data. (1) Rounding may cause discrepancies in totals. – (2) This item includes the proceeds of sales of public real estate with a negative sign. Table 2 General government revenue (as a percentage of GDP) Direct taxes 14.7 13.8 13.3 13.3 13.2 14.3 15.0 15.2 14.6 14.5 Indirect taxes 14.1 14.2 13.9 14.0 14.1 14.8 14.6 13.7 13.5 13.9 Capital taxes 0.1 0.2 1.3 0.6 0.1 0.0 0.0 0.0 0.8 0.2 Tax revenue 28.8 28.2 28.6 27.8 27.5 29.1 29.6 28.9 28.9 28.7 Social security contributions 12.1 12.2 12.5 12.6 12.6 12.6 13.1 13.7 13.9 13.7 Tax revenue and social security contributions 41.0 40.5 41.0 40.4 40.1 41.7 42.7 42.6 42.8 42.3 Other current revenue 3.5 3.5 3.4 3.6 3.5 3.6 3.5 3.6 3.8 3.8 Other capital revenue 0.2 0.2 0.3 0.3 0.3 0.3 0.3 0.2 0.2 0.2 Total revenue 44.7 44.1 44.7 44.3 43.9 45.5 46.5 46.5 46.8 46.4 Source: Based on Istat data. (1) Rounding may cause discrepancies in totals. BIS central bankers' speeches Table 3 General government expenditure (as a percentage of GDP) 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Compensation of employees Intermediate consumption Social benefits in kind Social benefits in cash Interest payments Other current expenditure Total current expenditure of which: excluding interest payments Gross fixed investment Other capital expenditure Total capital expenditure Total expenditure of which: excluding interest payments 10.5 5.0 2.5 16.1 6.2 3.3 43.7 37.4 2.4 1.8 4.2 47.8 41.6 10.6 5.1 2.6 16.5 5.6 3.4 43.6 38.1 1.7 1.9 3.6 47.2 41.7 10.8 5.2 2.6 16.7 5.1 3.6 44.0 38.9 2.5 1.9 4.3 48.4 43.2 10.7 5.3 2.7 16.8 4.7 3.6 43.9 39.1 2.4 1.5 3.9 47.8 43.1 10.9 5.4 2.8 16.9 4.6 3.7 44.2 39.6 2.4 1.7 4.1 48.3 43.7 10.9 5.1 2.8 16.9 4.6 3.6 44.0 39.3 2.4 2.7 5.0 49.0 44.3 10.6 5.1 2.7 17.0 5.0 3.7 44.1 39.1 2.3 1.7 4.0 48.2 43.2 10.8 5.4 2.7 17.6 5.2 3.8 45.4 40.3 2.2 1.5 3.8 49.2 44.0 11.2 5.9 2.9 19.1 4.6 4.2 47.9 43.3 2.5 1.9 4.4 52.3 47.7 11.1 5.8 2.9 19.2 4.5 4.1 47.5 43.0 2.1 1.4 3.5 51.0 46.5 Source: Based on Istat data. (1) Rounding may cause discrepancies in totals – (2) The figure for 2009 includes the extraordinary refund of the personal and corporate income tax overpayments made by firms in connection with the omitted deduction of 10 per cent of the regional tax on productive activities (IRAP) in the tax period up to 31 December 2008 (Article 6 of Decree Law 185/2006). Table 4 General government consolidated accounts on a current legislation basis as a percentage of GDP Net borrowing current capital Primary surplus Primary expenditure current capital Interest payments Total revenue of which: taxes and social security contributions Reduction in tax reliefs 4.6 1.6 3.0 -0.1 46.5 43.0 3.5 4.5 46.4 42.3 3.8 1.3 2.5 1.0 45.5 42.6 2.9 4.9 46.5 42.5 2.5 0.3 2.2 3.4 44.8 42.2 2.5 5.8 47.9 43.8 0.2 1.3 -0.8 2.1 4.9 44.2 41.7 2.5 6.1 48.1 43.8 1.0 growth rates 1.1 -1.0 2.1 5.2 43.9 41.4 2.4 6.2 47.9 43.7 1.2 Nominal GDP -0.6 1.2 -18.8 -0.3 0.9 -0.2 0.9 -14.0 10.2 2.3 0.0 0.8 -11.8 21.8 4.6 0.8 0.9 -0.5 7.5 2.6 2.1 2.2 0.6 4.3 2.3 1.9 1.9 1.6 2.2 2.7 Decree Law 201/2011 Effects on net borrowing (C = A - B) -1.3 -1.3 -1.3 Expenditure (A) -0.1 -0.4 -0.6 Revenue (B) 1.1 0.9 0.7 Source: Based on data published in Relazione al Parlamento 2011. (1) Rounding may cause discrepancies in totals. BIS central bankers' speeches Table 5 General government borrowing requirement (millions of euros) Year First 10 months Borrowing requirement net of settlements of past debts and privatization receipts 47,500 85,198 66,824 83,918 72,857 65,195 Settlements of past debts 1,653 1,519 1,171 1,653 1,519 1,171 -19 -798 -8 -666 -8 -1,560 49,134 85,919 67,002 84,424 73,025 63,679 Cash and deposits 4,224 8,487 4,508 -4,294 -5,437 of which: Post Office deposits -5,683 -1,487 -4,809 -1,407 -3,952 -3,006 Short-term securities 19,502 -7,405 -10,103 17,385 8,101 22,065 Medium and long-term securities 41,692 93,774 87,920 111,377 96,956 37,390 Loans from MFIs -1,132 2,814 2,270 1,539 Other -15,152 -11,752 -11,834 -53,625 -30,009 8,122 of which: deposits with the Bank of Italy -10,611 -11,399 -11,518 -53,131 -29,777 5,985 in securities in cash Privatization receipts Borrowing requirement FINANCING Memorandum item: Borrowing requirement financed abroad -10,287 -2,112 4,778 -709 5,098 (1) Post Office funds, notes and coins in circulation, and deposits held with the Treasury by entities not included in general government. – (2) Includes deposits held with the Bank of Italy and securitizations. BIS central bankers' speeches Table 6 Effects on the general government consolidated accounts of the budgetary measures adopted in the summer and of those introduced in the 2012 Stability Law (millions of euros) Reduction in net borrowing (Decree Laws 98/2011 and 138/2011 and Law 183/2011) as a percentage of GDP Decree Law 98/2011 (ratified by Law 111/2011) Decree Law 138/2011 (ratified by Law 148/2011) 2012 Stability Law (Law 183/2011) Revenue measures Decree Law 138 Corporate income surtax for the energy sector Decree Laws 98 and 138 Other corporate income tax measures Decree Law 138 Increase in the 20% VAT rate to 21% Decree Law 138 Tax on income from financial assets Decree law 98 Increase in the stamp duty on securities accounts Fight against tax evasion and provisions regarding Decree Laws 98 and 138 the collection of taxes Decree Laws 98 and 138 Gaming and excise taxes Other taxes on individuals (solidarity contribution and Decree Laws 98 and 138 increase in road tax for large cars) Decree law 98 Effects produced by measures affecting public employment and pensions Tax and social security reform and/or safeguard Decree Laws 98 and 138 clause Law 183 Award of radio frequencies Exemption from taxation of the productivity Law 183 component of pay Increase in social security contribution rate (separate Law 183 scheme) Law 183 Personal income tax on account Decree Laws 98 and 138 Other measures and Law 183 Expenditure measures Decree law 98 Rationalization of healthcare expenditure Decree law 98 Public employment measures Decree law 98 Local transport and the Infrastructure Fund Reduction in the expenditure of government Decree Laws 98 and 138 departments Decree Laws 98 and 138 Reduction in the expenditure of local authorities Decree Laws 98 and 138 Measures affecting pensions Decree Laws 98 and 138 Other structural measures Other measures regarding funds, expenditure Decree Laws 98 and 138 carryovers, equity interests in banks and international funds Law 183 Economic Policy Structural Intervention Fund Fund for urgent needs and Fund for financing sundry Law 183 interventions Law 183 International peace missions Employment Fund and Development and Cohesion Law 183 Fund Non-state schools and universities and Ordinary Law 183 University Fund Decree Laws 98 and 138 Other measures and Law 183 2,840 28,593 54,423 59,891 0.2 2,108 1.8 5,578 3.3 24,406 3.5 47,973 22,698 29,859 11,822 2,603 20,822 1,800 1,479 4,236 1,421 1,323 35,224 1,198 4,236 1,534 3,800 38,823 1,967 4,236 1,915 2,525 2,191 3,744 3,720 4,073 4,003 4,042 -6 -202 -471 -976 4,000 16,000 20,000 -895 -263 -750 -41 -237 -7,771 -19,199 -2,500 -64 -21,069 -5,000 -1,104 1,200 -1,700 -7,400 -6,300 -5,000 -4,000 -1,041 4,850 -6,400 -3,459 -6,400 -3,377 -1,002 -4,799 -1,342 -1,642 1,893 1,216 -184 -96 Sources: Based on data published in the Economic and Financial Document Update, Relazione al Parlamento 2011, and official assessments of the effects of the measures introduced in the 2012 Stability Law. (1) A negative sign indicates a decrease in revenue or expenditure. BIS central bankers' speeches Table 7 Effects on the general government consolidated accounts of the measures included in Decree Law 201/2011 (millions of euros) 32,326 35,119 37,093 Increases in revenue (A) Municipal tax and revaluation of cadastral incomes Municipal refuse and services tax Increase in excise taxes (including effect on VAT) Increase in VAT rate Personal income surtax – ordinary statute regions Personal income surtax – special statute regions Effects on revenue of the measures regarding pensions Realignment of equity interests Stamp duty on securities and financial instruments and products Duty on assets declared under the foreign assets disclosure scheme Taxation of large cars, aircraft and boats Other 25,483 11,005 5,901 3,280 2,085 1,043 1,095 24,584 11,005 1,000 5,879 2,085 1,095 24,115 11,005 1,000 5,857 2,085 1,973 Decreases in expenditure (B) Pensions Local authorities Suppression of organizations and entities Other -6,843 -3,850 -2,785 -22 -187 -10,534 -7,571 -2,785 -51 -127 -12,979 -9,969 -2,785 -101 -124 USES OF RESOURCES -12,141 -13,808 -15,669 Decreases in revenue (C) Reduction in the effects of the safeguard clause Allowance for corporate equity Deductibility of IRAP from corporate and personal income tax Deductibility of IRAP for young people and women Effects on revenue of the measures regarding pensions Other -7,587 -4,000 -951 -1,475 -149 -1,005 -7 -10,199 -2,881 -1,446 -1,921 -1,690 -1,920 -341 -12,024 -3,600 -2,929 -2,042 -994 -2,014 -445 Increases in expenditure (D) Pensions Tax credits for road hauliers Compensation fund for measures to promote growth Guarantee fund for SMEs and fund for exports Fund for local public transport Peace missions Other 4,554 1,074 1,000 3,609 1,074 1,000 3,646 1,074 1,000 17,896 -2,289 -20,185 14,385 -6,925 -21,310 12,091 -9,333 -21,424 SOURCES OF RESOURCES Net change in revenue (E = A + C) Net change in expenditure (F = B + D) CHANGE IN NET BORROWING (G = F - E) (1) Based on official estimates. – (2) The decree provides for an increase of 2 percentage points in the standard and reduced VAT rates with effect from October 2012. If implementing the delegated powers for tax and social security reform or the related safeguard clause does not produce €13.1 billion of additional revenue in 2013 and €16.4 billion in 2014, the increase in the two VAT rates will become permanent and there will be a further increase of half a percentage point in both. BIS central bankers' speeches Table 8 Total effect on net borrowing of the recent budgetary packages (millions of euros) Summer budgetary packages and the 2012 Stability Law as a % of GDP Revenue Expenditure Budgetary package under discussion in Parliament as a % of GDP Revenue Expenditure Total effect on net borrowing as a % of GDP Revenue Expenditure Memorandum item: GDP (Relazione al Parlamento 2011) -28,593 -1.8 -54,423 -3.3 -59,891 -3.5 20,822 -7,771 35,224 -19,199 38,823 -21,069 -20,185 -1.3 -21,310 -1.3 -21,424 -1.3 17,896 -2,289 14,385 -6,925 12,091 -9,333 -48,778 -3.0 -75,734 -4.6 -81,315 -4.8 38,718 -10,061 49,609 -26,125 50,914 -30,402 1,612,279 1,648,533 1,693,748 (1) A negative sign indicates a decrease. – (2) Includes the measures in Decree Law 98/2011 (ratified by Law 111/2011), Decree Law 138/2011 (ratified by Law 148/2011) and the 2012 Stability Law (Law 183/2011). – (3) Decree Law 201/2011. BIS central bankers' speeches Table 9 Objectives for the public finances and the budgetary packages (percentages of GDP and millions of euros) Economic and Financial Document (13 April 2011) Net borrowing 4.6 Primary balance -0.1 Debt 119.0 GDP Istat revision of GDP (19 October 2011) Debt GDP 133.1 3.9 0.9 120.0 2.7 2.4 119.4 1.5 3.9 116.9 0.2 5.2 112.8 167.5 -2,108 -5,578 -24,406 -47,973 277.0 Decree Law 138/2011 (ratified by Law 148/2011) Effect on net borrowing GDP 1,548,816 1,593,314 1,642,432 1,696,995 1,755,013 Decree Law 98/2011 (ratified by Law 111/2011) Effect on net borrowing Economic and Financial Document Update (22 September 2011) Net borrowing Primary balance Debt Memorandum item: 10-year BTP/Bund spread (basis points) -732 -22,698 -29,859 -11,822 433.7 4.6 -0.1 119.0 3.9 0.9 120.6 1.6 3.7 119.5 0.1 5.4 116.4 -0.2 5.7 112.6 1,548,816 1,582,216 1,622,375 1,665,018 1,714,013 398.7 118.4 1,556,029 516.0 2012 Stability Law (Law 183/2011) Effect on net borrowing -1 -2 -1 Decree Law 201/2011 Effect on net borrowing -20,185 -21,310 -21,424 376.0 (1) The effect takes account of the amendments to the safeguard clause contained in Decree Law 138/2011. BIS central bankers' speeches Table 10 Minimum contribution and age requirements for retirement Years Long-service pensions Employees age contribution period age + contribution period or: contribution period Additional months Years Years Years Old-age pensions age men women (private sector) 12 12 women (public sector) contribution period Self-employed workers age contribution period age + contribution period or: contribution period 42 and 1 month (41 and 1 month) 42 and 5 months 42 and 6 months (41 and 5 months) (41 and 6 months) 42 and 1 month (41 and 1 month) 42 and 5 months 42 and 6 months (41 and 5 months) (41 and 6 months) 66 and 3 months 66 and 3 months 62 and 3 months 63 and 9 months (63 and 6 months) (63 and 9 months) (64 and 9 months) 66 and 3 months 66 and 3 months (1) Interval between satisfaction of the requirements and payment of the first pension. – (2) An increase in life expectancy of (at least) 3 months is assumed – (3) For men. The figure for women is shown in brackets. From 2012 onwards there will be a 2 per cent penalty for every year persons retire before reaching age 62. – (4) From 2012 onwards there will be the additional requirement for persons aged less than 70 that their pension be equal to at least 1.5 times the old-age allowance. – (5) For employees. The figure for self-employed workers is shown in brackets. BIS central bankers' speeches Figure 1 Net borrowing (+) and lending (-) in the euro-area countries in 2010 (as a percentage of GDP) 34.5 34.5 33.0 33.0 31.5 31.5 30.0 30.0 7.5 7.5 6.0 6.0 4.5 4.5 3.0 3.0 1.5 1.5 0.0 0.0 -1.5 -1.5 Sp Ita N et h lg i Au G er ta Be M al Es Lu ai n Po rtu ga l G re ec e Ire la nd Eu ro ar ea 9.0 ly er la nd s C yp ru s Sl ov en ia Fr an ce Sl ov ak ia 9.0 st ria 10.5 m an y 10.5 um 12.0 to ni a xe m bo ur g Fi nl an d 12.0 Source: European Commission, Autumn Forecasts (2011). Figure 2 Gross public debt in the euro-area countries in 2010 (as a percentage of GDP) E ur o G re ec ar ea e Ita ly Au st ria Fr an ce G er m an y P or tu ga l Ire la nd Be lg iu m M al ta S pa in C yp ru N s et he rla nd s E st on Lu ia xe m bo ur g Sl ov en ia Sl ov ak ia Fi nl an d Source: European Commission, Autumn Forecasts (2011). BIS central bankers' speeches Figure 3 Composition of general government revenue in the euro-area countries in 2010 (as a percentage of GDP) nia to Es m xe Lu g ur bo e ov Sl Direct taxes nia a ov Sl kia nd nla i F ain Sp Indirect taxes ds us pr lan y r C e th Ne M a al t y d al ia ce an ium str lan tug an m u e r r r r el g o I A F e B P G Social security contributions It aly ce ee ro Gr Eu Other current revenue ea ar Capital revenue Source: European Commission, Autumn Forecasts (2011). Figure 4 Composition of general government expenditure in the euro-area countries in 2010 (as a percentage of GDP) nia to Es m xe Lu g ur bo ia ia nd ak en nla i ov ov l l F S S ain Sp Capital expenditure ds us pr lan r Cy e th Ne M a al t al ia m ny ce nd str tug giu an ma ela r r r el o I Au Fr e B P G Current expenditure, excluding interest payments ly Ita ea ce ar ee r o r G Eu Interest payments Source: European Commission, Autumn Forecasts (2011). BIS central bankers' speeches Figure 5 Twelve-month cumulative borrowing requirement (billions of euros) 100.0 100.0 90.0 90.0 80.0 80.0 70.0 70.0 60.0 60.0 50.0 50.0 40.0 40.0 State sector General government Unconsolidated central government 30.0 30.0 20.0 20.0 10.0 10.0 Source: For the state sector, the Ministry for the Economy and Finance. (1) Excluding privatization receipts. Figure 6 State budget tax revenue (percentage changes) 15.0 15.0 10.0 10.0 5.0 5.0 0.0 0.0 -5.0 - 5.0 -10.0 -10.0 -15.0 -15.0 Tax revenue Employee withholding tax VAT Source: State budget. (1) Percentage change of the six-month moving sum with respect to the year-earlier period. BIS central bankers' speeches Figure 7 10-year government bond yield differentials with respect to Germany in 2009-11 (basis points) 1.700 1.600 1.500 1.400 1.300 1.200 1.100 1.000 Greece Portugal Ireland Italy Spain France 1.700 1.600 1.500 1.400 1.300 1.200 1.100 1.000 Jan. Feb.Mar. Apr. May June July Aug. Sep. Oct. Nov. Dec. Jan. Feb.Mar. Apr. May June July Aug. Sep. Oct. Nov. Dec. Jan. Feb. Mar. Apr. May JuneJuly Aug. Sep. Oct. Nov. Dec. France Greece Italy Ireland Spain Portugal (1) Updated to 6 December 2011. Figure 8 10-year government bond yield differentials with respect to Germany in 2011 (basis points) 1,700 1,600 1,500 1,400 1,300 1,200 1,100 1,000 Greece Portugal Ireland Italy Spain France Jan. Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec. France Greece Italy Ireland Spain Portugal (1) Updated to 6 December 2011. BIS central bankers' speeches 1,700 1,600 1,500 1,400 1,300 1,200 1,100 1,000 Figure 9 Average cost of the debt, average gross interest rate on BOTs, and gross yield on 10-year BTPs (percentages) 10.0 10.0 8.0 8.0 6.0 6.0 4.0 4.0 2.0 2.0 0.0 0.0 Average cost of the debt Average gross interest rate on BOTs Gross yield on 10-year BTPs (1) Updated to 30 November 2011. BIS central bankers' speeches | bank of italy | 2,011 | 12 |
Introductory remarks of Mr Ignazio Visco, Governor of the Bank of Italy, at the Bank of Italy conference in honour of Tommaso Padoa-Schioppa, Rome, 16 December 2011. | Ignazio Visco: Conference in memory of Tommaso Padoa-Schioppa Introductory remarks of Mr Ignazio Visco, Governor of the Bank of Italy, at the Bank of Italy conference in honour of Tommaso Padoa-Schioppa, Rome, 16 December 2011. * * * I am very grateful to all of you for being here today for this conference in memory of Tommaso Padoa-Schioppa. I am glad that we have been able to bring together so many of his colleagues and friends who down through the years had the fortune to appreciate his intellectual and human qualities. And I am especially glad that we are gathering here at the Bank of Italy, the institution where he spent a good part of his professional life and the environment in which he first built an international reputation. An institution that, like the others he worked in, he helped to forge and to which he always remained deeply attached. For many of us Tommaso was more than a colleague; he was also a friend and a mentor. You could always count on his advice, his ability to anticipate and find concrete solutions to problems. Conversation with him was always enlightening; you benefited from having your ideas challenged, you sharpened your reasoning, you learned, from his example, how to deliver results. In the year since his untimely death I have often missed his wisdom and acumen, his lucid vision of the road ahead, and I have often found myself trying to guess what his advice would have been at a time when we face so many difficult challenges in Italy, his native country, and Europe, the ideal to which he devoted much of his life. Tommaso was devoted to his country and was always conscious of its great potential. But his innate optimism did not blind him to its serious weaknesses or to the troubles that lay ahead. He considered Italy a country suffering from a grave illness: twenty-five years of healthy growth after the Second World War had been followed by two decades of growth achieved with “toxic stimuli”: “a combination of inflation and currency devaluation, deficitfinanced public expenditure, accumulation of debt and impoverishment of capital”.1 The result was a country at once heavily indebted and under-capitalized, growing too slowly, where social inequalities were bound to increase. With his writings, speeches and actions, as Minister for the Economy he sought to instil a sense of urgency in an often hostile political environment: it was vital to act immediately and simultaneously for stability, growth and social equity. A sense of urgency, I must say, much vindicated by recent events. The underlying problem, in his view, was that Italy had lost the ambition to excel. As he put it so vividly, “Italy is like a cyclist who is capable of extraordinary sprints to catch up with the group, but incapable of taking the lead or breaking away. It seems that only the anguish of lagging behind and the nightmare of being excluded enable us to summon up the energy and the will to do our best.”2 Well, once again we are at a point where it is imperative to demonstrate our determination to react to an emergency; but it is also time to take, as Tommaso used to say, a longer-term view of the problems of the Italian economy and to tackle the structural impediments to sustained growth. With regard to Europe too, in his last years Tommaso saw his fears materialize, with alarm and some bitterness. Although he is rightly considered one of the architects of the euro, he sensed from the very start that the single currency was an unfinished project. He was among the first to warn of the dangers of a “currency without a State”. He was deeply dissatisfied T. Padoa-Schioppa (2007), “Intervento del Ministro dell’Economia e delle Finanze all’Assemblea dell’Associazione Bancaria Italiana”. Corriere della Sera, 16 May 2005. BIS central bankers’ speeches with the political inertia that had followed the introduction of the single currency. He clearly perceived the risks posed by inadequate governance in the macroeconomic field, in financial regulation and supervision, and by a union that “failed to satisfy, even for the functions that have been attributed to it, the cardinal principles of western constitutionalism (balance of powers; the democratic vote; the majority principle)”.3 He pleaded unflaggingly for a closer political Union. Tommaso was not an academic economist. He had a special gift for using insights from theoretical economics to challenge received ideas and established practices. At the same time, he challenged academic economists to go beyond simplistic behavioural assumptions and to take the role of institutions fully into account. Institutions and their design indeed constituted a leitmotif in his thinking, whether in connection with central banking, market infrastructures, European integration or global monetary arrangements. He always stressed the need to clearly identify the nature and scope of the public good that needed to be provided in order to design the most suitable set of rules and institutional framework case by case. At the same time, he had a dynamic view of issues and institutions: only by looking at underlying economic trends could one predict which new demands would drive the evolution of institutions in the future. Thus, for example, a fundamental insight of his – from early on in his career as an economist and, let me add, as a political scientist – was that growing economic and financial integration and interdependence, both in Europe and at the global level, would inevitably require a profound rethinking not only of how to allocate policy-making responsibilities but of the very concept of national sovereignty. He certainly did not underestimate the difficulty of this process or the resistance it would meet. Like Jean Monnet, Tommaso was fond of quoting the words of the Swiss philosopher Henri-Frédéric Amiel: “Experience starts over with every individual. Only institutions become wiser, as they accumulate the collective experience.” We can only add that institutions lucky enough to have had public servants as clear-minded and far-sighted as Tommaso Padoa-Schioppa really have had a chance to become wiser. To conclude, Tommaso’s example is a constant source of inspiration, a model of the kind described in one of his favourite quotes from Machiavelli: “A wise man ought always to follow the paths beaten by great men, and to imitate those who have been supreme, so that if his ability does not equal theirs, at least it will savour of it. Let him act like the clever archers who, designing to hit the mark which yet appears too far distant, and knowing the limits to which the strength of their bow attains, take aim much higher than the mark, not to reach by their strength or arrow to so great a height, but to be able with the aid of so high an aim to hit the mark they wish to reach.” [Machiavelli, The Prince, translated by W. K. Marriott (1908), Chapter 6] We have decided to commemorate Tommaso by taking his ideas as a starting point to discuss some of the burning economic issues of today’s real world, an approach, I believe, he would have appreciated. We have prepared four background notes, one for each session of the conference, to summarize his thoughts and legacy on each of the four themes that were at the centre of his work: monetary policy and payment systems, financial system regulation and supervision, the process of European integration, and the reform of the international monetary system. I think that the notes give ample testimony of the depth and vitality of his contribution. Corriere della Sera, 3 May 1998. BIS central bankers’ speeches Before the panel discussions, however, we will have the pleasure of being addressed by Italy’s Prime Minister, Professor Mario Monti, whom I thank warmly for confirming his acceptance of our invitation in spite of his many pressing engagements. BIS central bankers’ speeches | bank of italy | 2,011 | 12 |
Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the closing of the cultural days of the European Central Bank - Italy 2011, European Central Bank, Frankfurt am Main, 17 November 2011. | Ignazio Visco: Closing of the cultural days of the European Central Bank – Italy 2011 Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the closing of the cultural days of the European Central Bank – Italy 2011, European Central Bank, Frankfurt am Main, 17 November 2011. * * * Mr. President, Caro Mario, Cher Christian, Colleagues of the Central Banks, Ladies and Gentlemen, I attended this evening’s closing concert of the European Central Bank’s Cultural Days dedicated to Italy with great pleasure and it is with great pleasure that I now take part in this ceremony in which the baton passes to Christian Noyer, Governor of Banque de France. Since October 19 the public in Frankfurt has had the chance to meet many representatives of contemporary Italian culture, artists known and admired the world over and emerging young talents. In this month a gust of Italy seems to have blown across Frankfurt (thanks, too, to the coincidence that the cultural events happened to be held at the same time as the installation of an Italian president in the Eurotower). After our many years of work together in Banca d’Italia, I again express my best wishes to Mario Draghi as he takes up the challenge of his new position. Music has been the fil rouge of this month of Italian culture, inaugurated by the Orchestra Mozart of Bologna under the direction of Maestro Claudio Abbado and concluded this evening by the remarkable and fascinating performance of the Orchestra Verdi of Milan under Maestro Xian Zhang. In between, the master violinist Uto Ughi performed on the occasion of the Charity event. To be sure, there has been no lack of significant moments dedicated to the other expressions of Italian culture, with the participation of great contemporary Italian writers, such as Claudio Magris and Dacia Maraini, and the projection of a series of Italian movies in which six directors confronted the theme of the family between tradition and modernity. Contemporary music, too, has been showcased, with the virtuoso, high-energy performance of Stefano Bollani, one of Italy’s most celebrated young jazz musicians. Still, we wanted to open and close the programme in the grand tradition of classical music. The two orchestras – the Mozart of Bologna and the Verdi of Milan – have an important common denominator: both are examples of how superb results can be achieved when there is the active will to discover and promote young performers and the conviction that music is both a means of education and a vehicle of ethical principles in society and for the formation of the younger generations. It was precisely this will and this conviction that gave birth to the Orchestra Verdi in 1993 and the Orchestra Mozart in 2004. Both testify to the richness of cultural life in today’s Italy and to the presence in our country of a host of ambitious and successful initiatives for cultural development. My sincere thanks naturally go to the one of the great protagonists of this initiative – the public of Frankfurt. As in past editions, an extremely discerning public has given the Cultural Days the warmest welcome and responded enthusiastically to the events on the programme. It is a great pleasure to have this further confirmation of the interest that the Germanspeaking world has traditionally taken in Italy. From Goethe’s time, from Frankfurt indeed right down to the present, in fact, the Italienreise has remained a significant part of the formation of artists and thinkers north of the Alps. Aside from our reciprocal stereotypes, about which so much has been written in both a serious and a humorous vein, the German people – intellectuals, professionals, simple tourists – have always had a love for Italy. A special cultural bond between the two countries has been formed. [A journalist from Turin who lived for many years in Hamburg, referring to Germans’ appreciation of the Italian BIS central bankers’ speeches lifestyle, gave his book on the relationship between the two cultures an efficaciously ironic title: “La Deutsche Vita”.] Banca d’Italia has always appreciated the role played by art and culture in nurturing the mind and creating a common national and European identity, so for our institution it has been a pleasure to take part in organizing the Cultural Days this year. Among other benefits, I believe that these events shorten the distance between citizens and central banks, enabling the public at large to become familiar with our institutions and showing our generally “austere” class of central bankers in a different light. This was one more reason why Banca d’Italia was glad to embark on this “adventure”. My thanks to the staff of the European Central Bank and of the Banca d’Italia for their dedication and hard work, and for the excellent results attained. The ECB’s Cultural Days undoubtedly help to reinforce “unity in diversity” as Mario Draghi just recalled. This motto of ours, coined by Jean-Claude Trichet, fully reflects the creative potential inherent in our heterogeneous Europe. In his remarks at the Literaturhaus on October 20th Claudio Magris, rightly considered the “most European” of contemporary Italian writers, described the European identity not as a set of roots delving down into the earth but as the branches of a tree reaching outward and intertwining with the branches of other trees. To me, this image is most evocative. Each of the individual national identities that contribute to our European identity is exactly like a tree, with its own deep roots in history and centuries’ worth of fruit, but above all horizontally outstretched towards transparent, vital enlacement with its equally fruit-laden neighbours. In closing, let me offer my best wishes to Governor Noyer – and to the European Central Bank – for the preparation of next year’s Cultural Days. I am curious to learn the programme of events devoted to French culture. I am certain that Frankfurt will be treated to the best of France’s immense cultural heritage, in its profoundly European dimension yet also bearing the signs and the fruits of its contact with the other great civilizations of the world. BIS central bankers’ speeches | bank of italy | 2,011 | 12 |
Talk by Mr Ignazio Visco, Governor of the Bank of Italy, at the 30th National Congress of the Italian Association of Children's and Family Court Judges (AIMMF), Catania, 25 November 2011. | Ignazio Visco: Investing in knowledge – young people and citizens, training and employment Talk by Mr Ignazio Visco, Governor of the Bank of Italy, at the 30th National Congress of the Italian Association of Children’s and Family Court Judges (AIMMF), Catania, 25 November 2011. * * * When I was asked to speak at the 30th National Congress of the Italian Association of Children’s and Family Court Judges (AIMMF), I certainly did not imagine that it would be one of my first talks as Governor of the Bank of Italy. So I have wondered whether it might not be best to withdraw from the engagement, since the issues one would expect me to deal with in my new role might be thought to be different, more pressing. But the reasons that led me to accept your invitation in the first place have not lost any of their force. The title of this session, “We are born children, but we become citizens”, not only imbues our everyday economic policy efforts with ultimate meaning but also prompts us to examine the structural problems holding our economy back, and to think about schools and education, publicspiritedness and respect for the rule of law, and human and social capital. And that is what I intend to do here today. It means tackling the issues key to the economic and human progress of our country. The current economic and financial crisis The economic and financial crisis that began in 2008 has compounded the difficulties that the Italian economy had been struggling with for a decade. Between 1995 and 2007, per capita GDP had grown on average by just over 1 per cent a year, compared to nearly 2 per cent in the euro area. The recession that hit almost all advanced economies in 2008–09 struck more profoundly in Italy than elsewhere. Even with little or no growth, the low interest rates made possible by the adoption of the single currency and measures aimed at public finance adjustment made the cost of servicing the large public debt bearable. In recent months, however, the heightened tension in financial markets has made this balance precarious, fueling operators’ doubts over the sustainability of Italy’s sovereign debt. The measures adopted starting this summer have improved the public finances but are not sufficient to achieve the lasting, structural rebalancing that the country needs in order to return to growth. Italy’s failure to thrive is in good part due to the hesitancy with which the economy has responded over the past twenty years to the challenges of technological innovation, the emergence of new economies in the world arena, and the powerful increase in European integration. Entry into the monetary union did away with the ephemeral gains deriving from the devaluation and imposed greater fiscal discipline on Italy in order to qualify for membership. Boosting growth potential requires wide-ranging measures, including a reform of the institutions responsible for economic governance, to stimulate business activity and encourage sustainable work inclusion, especially of women and youth. The main measures needed have long been perfectly well known and include: heightened competition, particularly in protected service sectors; wider access to risk capital, especially for innovative firms; regulation of the labour market and a social welfare system which, acting together, help reallocate human resources towards more productive uses; and a more efficient civil justice system. There is, however, one further point that is at least as important, namely measures to increase the stock of human capital. BIS central bankers’ speeches Human capital and new technologies Economists have always paid heed to the role of education and knowledge in increasing the productive capacity of individuals. More recently, we have come to use the term “human capital” to indicate people’s endowment of skills, technical ability and know-how. The term thus recognizes the economic value of this endowment in improving the quality of work, increasing the efficiency of production processes and facilitating the adoption and development of new techniques and products, with benefits to individuals and the system as a whole. This pool of skills and knowledge evolves over time in response to changes in the technological paradigm. Starting in the 1990s, the rapid spread of new information and communications technologies and their constant advancement have radically changed the nature of the skills demanded by the productive economy. New technologies enable the automation of routine activities that require the simple application of standard skills and can be codified into sequences (however long) of instructions. The new technologies tend to reduce the demand for labour for all such activities, while they favour managerial and intellectual roles, and, to a lesser extent, non-repetitive manual jobs as well. Where such trends have been more pronounced, they have been of less benefit to those with intermediate education levels, mainly associated with the possession of a standard skill set. No longer is human capital acquired once and for all at school and then applied in standard fashion throughout one’s entire working life. What educators call “competence” has become crucial: namely, the ability to mobilize internal resources (knowledge and know-how) and external resources in an integrated way to cope with often unprecedented and non-routine situations. “Competence” interacts with innovation and enables rapid adaptation to change; together with specialized knowledge, it allows innovation to emerge from the everyday, by effectively combining available resources with known concepts. These are the inputs necessary to a fundamental change of gear for mature economies, which need to shift away from a model of growth based essentially on emulation and progressive advance towards a technological frontier to one centring on the ability to generate innovation independently, thus advancing the frontier itself. It will be increasingly necessary to cultivate 21st-century skills, namely critical thinking and an aptitude for problem-solving. Traditional areas of knowledge (including languages, mathematics, science, economics, civics, but also history, art, geography, and our great tradition of classical education) will continue to be an indispensable resource, but will need to be integrated within a dynamic context in which receptiveness towards innovation, as well creativity, intellectual curiosity, the ability to communicate effectively, and openness to collaboration and teamwork, will be decisive. Italy’s laggard performance Italy is lagging behind the main developed countries, both in high school and university education and in the skill levels of young people and the adult population. Italy’s low stock of human capital by international standards is a longstanding issue. At the time of national unification in 1861, the adult population averaged less than one year of education as against four or five in France, Germany, the United Kingdom, and the United States. As Giovanni Vecchi recalls in his recent book In ricchezza e in povertà, at the beginning of the last century two British historians, Bolton King and Thomas Okey, observed in a volume entitled Italy Today: “Education is the gloomiest chapter in Italian social history, a chapter of painful advance, of national indifference to a primary need, of a present backwardness, that gives Italy (next to Portugal) the sad primacy of illiteracy in Western Europe”. Since then, there has been considerable progress in education levels, but not enough to bridge the gap. In 2009, according to the latest OECD figures, 54 per cent of Italians aged BIS central bankers’ speeches between 25 and 64 years had earned a senior high school diploma, compared with the OECD average of 73 per cent. The gap was narrower but still substantial for younger age groups: in the 25–34 age bracket, the proportion of Italian senior high school graduates rose to 70 per cent, against an OECD average of 81 per cent. The proportion of children completing junior high school studies has also been rising, gaining more than 10 points in recent years to over 80 per cent. For university education, however, the gap is certainly worrying. Here, Italy seems hard put to keep up with the other advanced countries: again in 2009, the proportion of graduates in the 25–64 age group was less than 15 per cent, or just half the OECD average; amongst people aged between 25 and 34 years, it exceeded 20 per cent, compared to an OECD average of around 37 per cent. Over the past twenty years, direct testing of reading comprehension, logical and mathematical skills, and the ability to combine pieces of information to solve problems of varying complexity, reveals a similarly worrying picture. At the end of primary school Italian students are at least as skilled as in the other developed countries, but in the later stages of formal education they fall behind. For 15-year-olds, the gap found by the PISA survey carried out by the OECD in 2006 corresponded to around one school year; and although this diminished between 2006 and 2009, it remained significant. The gap reflects severe disparities between different parts of Italy, with the scores in the North slightly above the OECD average and those in the South dramatically lower. These disparities are subject to various interpretations involving their geographical distribution or the discrepancies between different schools rather than within any individual school. Yet the fact remains that a country like ours, poor in material resources and now lagging on various fronts, should invest in “knowledge”, not “below” or “around” but above the average of other countries with more natural resources. Such deficits are also observed in respect of the skills of the adult population. The international Adult Literacy and Lifeskills Survey (ALL) conducted in 2003 to gauge functional literacy and numeracy together with analytical and problem-solving abilities shows that about 80 per cent of Italians aged between 16 and 65 are unable to apply linear reasoning and draw inferences of average complexity by extracting and combining information provided in written texts that are little more than basic. They are, that is to say, functionally illiterate: they lack adequate reading comprehension, logical and analytical skills to respond to the demands of modern life and work. This is the highest percentage in any of the advanced countries surveyed. For purposes of comparison, the corresponding figure in Switzerland and the United States is 50 per cent, in Canada 40 per cent, and in Norway 30 per cent. These deficits represent a milestone, all the more so for a country like ours with our longstanding shortfall in growth. This is why education policies should not seek just to close the gaps with the other advanced countries but must rather aim for a radical reversal of the situation. Collective decisions and individual choices In order to accomplish this, there is a need for reflection on the tools society uses to increase the stock of human capital and on the determinants of individuals’ educational choices. We must analyze both the places where human capital is developed, namely schools and universities, and the reasons for individual choices that sometimes seem unwarranted in light of the economic returns to education. Learning and research evaluation mechanisms, greater decision-making autonomy, and the linking of public funding to indicators of quality in teaching and research in universities are recognized internationally as important to the effectiveness of an educational system. The successive reforms in Italy in recent years seem to be a step in this direction, but the effort for improved and more efficient organization has been undermined by the inadequacy of both public and private resources devoted to the accumulation of human capital. And the situation risks getting worse in the current economic climate. In the middle of the last decade, a point BIS central bankers’ speeches in time for which an international comparison is possible, investment in knowledge – approximated by total public and private expenditure on higher education, research and development, and software – amounted to 2.4 per cent of GDP in Italy, as opposed to an OECD average of 4.9 per cent. The capacity of the educational system to absorb and generate new ideas has probably also been constrained by slower generational turnover, which has dramatically reduced the number of young people in teaching positions. According to OECD estimates for 2009, only 9 per cent of teachers in Italian senior high schools were under 40 years old, compared with 25 per cent in Germany, 34 per cent in France, and over 40 per cent in the United Kingdom and the United States. In the same year, according to the Eurostat database, 16 per cent of university teachers in Italy were under 40, as against 30 per cent in France, 39 per cent in the United Kingdom and 47 per cent in Germany. Yet despite these shortcomings, the metrics available indicate that education remains a worthwhile investment in Italy. People with more education have less difficulty in finding employment, have less discontinuous work careers and earn higher salaries. According to the OECD, in 2009 the average earnings gap in the adult population between people with at most compulsory schooling and high school graduates was close to the average for the developed countries, whilst that between the latter and university graduates, although smaller than in the other major countries, was close to 50 per cent (compared to 63 per cent in France, 67 per cent in Germany, 78 per cent in the United Kingdom and almost 90 per cent in the United States). The additional return over and above that from a senior high school diploma of a degree in a scientific discipline is, in Italy, between three and four times greater than that derived from a degree in the humanities. Yet, at the end of the last decade, 20 per cent of young people between the ages of 18 and 24 with a junior high school certificate had not gone on to any further qualification, about half of young people aged 20–24 with a senior high school diploma had not enrolled at a university, and of those that had gone to university, nearly half failed to complete their degree. So what are the reasons for this apparent discrepancy between the returns to education and people’s educational choices? Firstly, the economic benefits of higher education are not properly perceived. According to the results of a survey for the European Commission this year, scarcely half of young Italians see higher education as advantageous. This is the lowest proportion amongst all EU countries. Approximately two-thirds of Italian respondents recognized that university training does improve job opportunities, but only a third – less than in all the other countries surveyed – expected a gain in terms of higher remuneration. This lack of awareness exacerbates the consequences of the obstacles (often economic in nature) to investment in education. The strong correlation between family background and educational choices reduces social mobility. Individuals suffer as a result, and so too does society as a whole, which fails to cultivate and use talent emerging from less privileged backgrounds. Learning and integration difficulties are even greater for the children of foreign nationals. By the end of primary school, around a third of them, compared with 2 per cent of Italian children, have already fallen behind the normal education cycle, and the disadvantage is amplified in later years, as is shown by the smaller proportion promoted to junior high school and their greater likelihood of dropping out at the end of compulsory schooling (twice as high as among Italians). In the absence of effective integration mechanisms, our country’s stock of human capital thus risks being further penalized by the rapid increase in the relative proportion of young people with foreign backgrounds, which Istat projects to exceed 30 per cent by 2050. Furthermore, the Italian economy’s ability to reward and make the most of human resources remains poor. Wage differentials by educational attainment are not only smaller than in other countries but are much smaller for younger than for older workers. Entry-level wages are BIS central bankers’ speeches now at the same level, in real terms, as decades ago, and people entering the workforce today appear to be precluded from the income growth registered in the meantime. This is probably due to the hesitancy – compounded by the financial and economic crisis – with which Italian industry has adapted to the trends that have changed the world so radically. It is possible that the generally inadequate standard of education provided by the school system – at least as perceived by firms – is a factor in the low salaries offered (and the accordingly low investment in human capital). In terms of the labour market, increased flexibility has certainly facilitated the absorption of the very high levels of unemployment registered in the mid-1990s. But while it has sustained the employment of young people, this increased flexibility – together with protracted wage moderation – may have led firms, especially the less efficient ones, to put off investment in R&D and advanced technologies. Indirect evidence of this is the fact that, in the teeth of conventional economic theory, Italy’s shortage of the human capital required by the new technological environment is linked to the comparatively low extra return to university graduates entering the labour market. So far I have concentrated on university education, a key component in the human capital stock of any modern economy, as it furnishes specialized skills that are not readily codified and that form the basis for the further advancement of knowledge and, hence, the technological frontier. Good graduates are produced by good universities, but, above all, good universities are in need of good students who are capable of learning to think critically and creatively to solve problems. Such students are cultivated at the lower levels of the education system, and many recent studies concur that investment in knowledge directed towards the early years of education is the most effective, and that learning deficits at this stage are difficult to make up for in subsequent years. Human capital and social capital Investing in knowledge, especially in the early years of schooling, is important for many reasons, not just because of the positive effects on the productivity of individuals. The benefits of education go beyond private financial gain. For instance, better-educated people on average enjoy better health, due also to their increased awareness of the value of prevention and the cost associated with risk behaviors. According to Eurostat, at 25 years of age the residual life expectancy of a male Italian senior high school or university graduate is 58 years, compared with 53 for those with only compulsory schooling (for women, 62 and 59 respectively); at 65 years of age, the gap in life expectancy is reduced but not eliminated, still amounting to two years for men and one year for women. The benefits of better education extend to many other aspects of life. Of special significance to this particular gathering is its positive influence in curbing lawlessness. Whilst we do not have a statistical breakdown for Italy, the data for Sweden and the United States show that a higher average level of schooling brings a substantial reduction in the crime rate against both persons and property. Among other things, this results in significant cost savings for the community. This outcome is the product of various mechanisms. In strictly financial terms – other things being equal – education reduces the incentives for crime by decreasing the gain compared to that achievable through legal means. Furthermore, there is a cultural impact stemming from the enhanced opportunities for socialization of people going to school compared with dropouts. Conversely, an increase in lawlessness in a community or area may reduce the incentives for school attendance for young people who are lured by the prospect of even small but immediate gains and driven by a strong copycat effect. It is no surprise, then, that it is in social milieus and geographical areas with lower levels of schooling that crime is rife. Nor is it an accident that those same circles and areas have a smaller stock of “social capital”, a factor increasingly recognized as important also to economic development. BIS central bankers’ speeches A community of educated and socially aware individuals, which is more likely to condemn deviations from legality and to recognize the benefits of cooperation, is in fact also more inclined to subscribe to values and norms that facilitate the achievement of the shared goals with which “social capital” is frequently identified. For our country this is a particularly meaningful concept, whose broad modern acceptance derives from Robert Putnam’s celebrated study of Italy’s regional administrations. It was that study that turned the spotlight on the poorer endowment of social capital in the regions of southern Italy compared to the Centre and North. In a market economy, social capital plays a central role by lowering transaction costs and so facilitating commerce between economic agents. This benefits the degree of financial development, the average size and innovation propensity of firms, the design of institutions, and, ultimately, the rate of economic growth. In contexts where education, trust in others and willingness to cooperate are limited, vertical relationships characterized by subordination, cronyism and exploitation are more likely to prevail. It is in such conditions that lawlessness can take hold and crime – including organized crime – spread more easily. The social and economic costs can be enormous. Some Italian work has used econometrics to gauge the extent to which the North-South development gap can be ascribed to organized crime. Comparing per capita GDP in some southern regions (where crime has taken hold in relatively recent years) and in several regions in the Centre and North (which had statistically comparable baseline characteristics but where organized crime has not become similarly entrenched), it is estimated that the cumulative economic growth of the former in the thirty years from 1977 to 2007 was some 15 percentage points less. The corresponding impact on the development of regions marked by the long-established presence of mafia-style organized crime can be assumed to be greater still. Whilst these are estimates to be treated with great caution, they do give an indication of the relevance of crime to the inhibited development of the southern regions and of the entire country. How does one go about augmenting a community’s social capital? Civic sense, trust, and willingness to cooperate are values that take time to ingrain themselves, and they display considerable persistence over time. Putnam even traces the current regional discrepancies in Italy back to the different political regimes prevailing in the late Middle Ages. Other scholars, however, maintain that the endowment of social capital can be increased – albeit slowly – by working on factors more directly influenced by policy choices. The role of schools and education is central. There is a strong correlation, for instance, between the literacy levels in the different regions of Italy at the end of the 19th century and the degree of trust in others observed today. Education level is not the only thing that matters, though. International data also suggest the importance of teaching methods: where active participation and teamwork by students is favoured over the traditional hierarchical relationship with teachers, one finds more trust in others and in institutions as well as more cooperative attitudes. Where more horizontal teaching methods predominate, one may find greater willingness to delegate decision-making within firms and less conflict in the organization of labor. Some concluding considerations Like other countries in Europe and around the world, Italy is going through a very difficult stage. But our economic problems are only partly the consequence of the severe global recession. Rather, their origins go far back and are rooted in structural characteristics; today’s financial troubles reflect the budgetary policies of past years. There can be no illusion that macroeconomic interventions are capable of remedying these shortcomings, and this is not so much due to their now limited scope for action as to the belief that only by resolving its structural weaknesses can the Italian economy gain a new lease on life. Our economy must be made more inclusive through increased labour market participation, especially for young BIS central bankers’ speeches people and women, by eliminating the needless obstacles to economic activity and the barriers connected with family background. This is the meaning of the continual calls for the removal of constraints, vested interests, and restrictions on competition and economic activity. The lack of competition curbs output and employment in many sectors, impinges on competitiveness and the innovative capacity of the entire economy, hinders the regeneration of a manufacturing base that is still too fragmented, and prevents talent from emerging. The institutional system must be such as to favour business dynamism, growth, stability and certainty in the regulatory framework, and to overcome the infrastructure deficit, particularly in high-tech sectors. The North-South labour market divide can be overcome through comprehensive regulatory and welfare reform; more decentralized and flexible collective bargaining arrangements could enable the remuneration and organization of labour to be better tailored to actual production conditions. Particular attention should be paid to the southern regions, where structural weaknesses are more acute. Human capital and investment in knowledge represent one of the key economic policy variables. The economic returns both to the individual and to the community are unquestionable. They are important not only for their direct impact on productivity but also for their indirect effects, which emerge in the interaction between individuals, in the growth of public spirit, respect for the law and belief in the triumph of justice, and the fight against corruption and crime – two major factors curbing sustained and continuous economic growth. It is clear, however, that despite the great advances since national unification we have not yet made good Italy’s historical lag. There is a pressing need for a strong commitment, both in the public and private sector, to invest in knowledge now, in order to break the vicious circle of the small stock of human capital and its undervaluation. As an economist, I have considered the consequences of human capital for economic development. However, this talk is not intended to offer a mechanical or one-sided vision of the dynamics of this relationship. It would be narrow-minded to think that knowledge is important and should be invested in solely because it can increase our rate of economic growth. Knowledge, learning, can also help to stimulate public spirit and increase social capital, both of value in and of themselves quite apart from the benefits to economic growth. In other words, investment in knowledge constitutes a crucial factor in social cohesion and welfare. BIS central bankers’ speeches | bank of italy | 2,011 | 12 |
Address by Dr Ignazio Visco, Governor of the Bank of Italy, to the 18th Congress of Financial Markets Operators organised by ASSIOM FOREX (the Financial Markets Association of Italy), Parma, 18 February 2012. | Ignazio Visco: The sovereign debt crisis and the outlook for Italy Address by Dr Ignazio Visco, Governor of the Bank of Italy, to the 18th Congress of Financial Markets Operators organised by ASSIOM FOREX (the Financial Markets Association of Italy), Parma, 18 February 2012. * * * Last November the spread between the yield on ten-year BTPs and their German equivalent reached 550 basis points; yesterday at the close it stood at 365 points; in the first six months of 2011, it had been mostly below 200 basis points. Tensions remain high in the international financial markets. The difficulty in resolving the Greek crisis, evident again in recent days, is transmitting turbulence to the entire European market. Investor uncertainty over Italian government securities has eased with respect to the worst moments of the crisis, but has not disappeared. The markets’ attention is now focused on Italy’s ability to make further determined progress in the restoration of its public finances and simultaneously stimulate its economic growth potential through structural reforms. The path has been set with clarity of purpose; international public opinion acknowledges as much; it must now be followed with perseverance and resolution. But no-one can succeed on their own. To lower the risk premiums on the government securities of the countries engaged in financial stabilization and the revival of output, decisions must be taken by common accord. The determination of all to reinforce the European construction is essential. In recent months Italy’s economic policy has taken steps towards financial sustainability which were once deemed inconceivable, for example regarding the pension system. Equally bold steps are expected on other, decisive fronts, to which the Government is already committed: the efficiency of the taxation system and the fight against tax evasion; the public sector spending review, which will analyze every item to identify possible redundancies and savings; and the simplification of laws, institutions and practices that are blocking the country’s energies, reducing firms’ competitiveness and frustrating the expectations of the younger generations. 1. The sovereign debt crisis and the outlook for Italy For two years now the global financial crisis has found a new and dangerous focus in the euro area. The turbulence was initially confined to Greece, whose budget situation had long been obscured by the official statistics; it then spread to Ireland, which suffered the consequences of the profound crisis in its banking sector, and to Portugal, penalized by its foreign trade deficit. The limits of euro-area governance have become apparent. Multilateral monitoring of national economies failed to ensure sufficiently prudent budgetary policies in good times, and underestimated the macroeconomic imbalances of several countries. The initial lack of satisfactory instruments for managing and resolving sovereign debt crises has been compounded by the faltering and scarcely effective progress of the Greek aid programme and the drawn-out negotiations for governance reform. Tensions in the financial markets assumed systemic proportions from the summer onwards, following the announcement of private-sector involvement in the proposed resolution of the Greek crisis, despite this being presented by the Eurogroup as a unique and exceptional case. The turbulence spread to Spain, which suffered the consequences of a fall in property prices, and Italy, with its high public debt and weak growth prospects in the medium term. The financial markets, which had long underestimated the possibility of default by a sovereign issuer in the euro area, to the point of tacitly ruling it out, now began to give BIS central bankers’ speeches excessive credit to this scenario, involving countries whose fundamentals warranted less negative assessments. The markets – operators, analysts – clearly struggle to produce a sound interpretation of all the available information, which is sometimes incomplete or lacking in transparency; above all in the phases of acute uncertainty, operators tend to engage in the kind of herd behaviour that fuels financial contagion. In turn economic policy – particularly in the institutional context of the single currency – is hard put, in its regulations and interventions, to respond rapidly to fluctuations in the prevailing opinions in financial markets, to curb excesses, and to channel its response towards a stable and effective equilibrium. To assess sovereign risks in a timely and independent fashion, taking account of the conditions and prospects of the public finances, the level and trends in private sector debt, and countries’ growth prospects, is clearly no easy task. It requires the commitment of very substantial resources and the rating agencies have not always been up to the mark. Appropriate standards must be defined; there is a need for transparent working relations between the agencies and independent, national and supranational institutions, charged with carrying out analogous assessments. The measures adopted by Italy during the summer to bring budget balance forward to 2013 and the acceleration of the EU governance reform process with the definition of the “Six-Pack” in the autumn, did not succeed in alleviating the tensions in the financial market. Instead, the concerns over the adequacy of the European financial support mechanisms and the fears over the weakening of the international economy prevailed. There was a sharp worsening of wholesale funding conditions for banks in Italy and the other countries exposed to tensions, whose creditworthiness has been treated as equal to that of their respective governments. US money market funds basically stopped buying commercial paper; unsecured bond issues dried up. Strong fears were aroused by the large volume of bank bonds maturing in the first part of 2012. In Italy, as in other euro-area countries, funding difficulties were increasingly affecting credit supply conditions. There was a real risk of a severe restriction of funding for the economy. The Governing Council of the European Central Bank lowered the rate on the main refinancing operations rate by 25 basis points in November and again in December, bringing it down to 1.0 per cent. In December, the Council also introduced three-year refinancing operations, announced an expansion of the range of assets eligible as collateral, and halved the compulsory reserve coefficient. Carrying out its function as supplier of liquidity to the banking system with determination, the ECB countered the banks’ fund-raising difficulties and the restriction of credit. The action of the ECB, the incisive budget measures taken in the countries suffering from the worst financial turmoil, and the reaching of an agreement for stronger cooperation under the fiscal compact have succeeded more recently in easing the strains in the government securities market and in banks’ balance sheets. Monetary policy alone cannot resolve the crisis. Along with a consolidation of public finances there must be structural reforms for vigorous and balanced growth; the rules of the fiscal compact must be rapidly implemented. The financial support mechanisms at European level must be made to work with greater agility and more effectively; the adequacy of their intervention capacity must be ensured. The threat of dangerous contagion must be definitively dispelled by resolving the problem of Greece. In Italy the three budget correction packages passed between July and December 2011 should lead to a primary surplus on the order of 5 per cent of GDP in 2013 and a reduction in the debt ratio. The adjustment will come mainly from an increase in revenue but expenditure savings will increase over the three years 2012–14. The pension reform will immediately reinforce the financial sustainability of the pension system by setting stricter requirements. In the medium term the Italian economy’s capacity for strong and stable growth must be restored, by making firms more competitive. GDP is still 5 points BIS central bankers’ speeches below the level reached in 2007, before the crisis; households’ real disposable per capita income is down by 7 points and industrial output by a fifth. The deficit on the current account of the balance of payments remains large. The reforms decided must be rapidly completed and put into effect, in particular those to make the regulatory and administrative structure favourable rather than unfriendly to economic growth: the liberalization of important service sectors, the effective simplification of administrative acts, the better functioning of the labour market, special attention to human capital and innovation, and faster responses by the judicial system. Even if the effects of individual interventions will arrive gradually, a comprehensive and wide-ranging plan can have a positive influence on expectations in the short term and so stimulate aggregate demand and a recovery in investment. The point is to create favourable conditions for those who invest and create jobs in Italy not with subsidies but by furnishing suitable intangible infrastructure; not through the shadow economy but by cracking down on tax evasion. Society pays a high price for corruption and crime in general in the form of deteriorating civic life and lost economic development. Combating them, and especially their financial implications, will remove one of the brakes on growth. Economic growth favours the consolidation of the public finances, which in any case are already on a sustainable path, even under unfavourable assumptions concerning growth and interest rates. With modest real growth of around 1 per cent and a spread on ten-year government bond yields stable, if high, at 300 basis points, primary surpluses of 5 per cent of GDP, as forecast for 2013, will reduce the debt ratio by more than is required by the new European budget rules. This year will be a year of recession. As we indicated in the forecasting scenarios set out in our Economic Bulletin in January, we expect a year-on-year decline in gross domestic product of about 1.5 per cent. But it is important to look ahead, to act in such a way that as conditions in the financial and credit markets return to normal it will be possible to stabilize economic activity in Italy already by the second half of 2012 and return to growth next year. 2. Bank liquidity, the extraordinary measures of the Eurosystem and credit to the economy Italian banks are sound, but they have been especially hard hit by the sovereign debt strains. Since last summer short-term fund-raising in dollars and funding on the bond market have slowed to a trickle, while the fall in government securities prices and the raising of margin requirements by the main lenders have limited the banks’ access to repos. One factor in market instability and the consequent funding difficulties has been the operation of automatic mechanisms. This occurred, for instance, on 9 November, when the French central counterparty, LCH Clearnet SA, drastically raised its margin requirements against positions in Italian securities, in line with the sovereign risk framework of the British member of the Clearnet Group. Italy’s Cassa di Compensazione e Garanzia, linked to Clearnet through an interoperability agreement, had to adapt in order to avoid jeopardizing the orderly functioning of the market. Afterwards, the competent authorities asked the two central counterparties to review the decision and to develop a common methodology for assessing sovereign debt risks. The process must be based on an adequate statistical base, avoid automatic links with rating agencies’ assessments, and curb the potential pro-cyclical effects. In the course of 2011, while residents’ deposits and bonds held by households remained stable, Italian banks’ overall fund-raising from customers and the markets slowed and from November started to contract. For 2011 as a whole, it declined by 2.8 per cent. At the same time, the banks’ recourse to Eurosystem refinancing increased considerably. A real risk was emerging that the difficulties of raising funds in the international markets would result in a BIS central bankers’ speeches contraction of lending, aggravating the cyclical downturn and inevitably triggering feed-back effects on the banks’ balance sheets. Until November Italian banks’ lending to the non-financial private sector continued to expand, although at diminishing rates. In December, however, loans to firms contracted by about €20 billion. The decline is very large by historical standards, although it may have depended in part on the usual volatility of end-year data. Lending to households diminished only slightly. Preliminary data indicate a slight further contraction in credit in January. Certainly firms’ demand for credit has declined, given the poor state of the economy, but surveys of banks and firms indicate a tightening of credit supply terms as well. The Italian banks participating in the Eurosystem’s quarterly Bank Lending Survey confirm that the rise in lending rates and the strains on credit supply are due mainly to serious difficulties in raising funds in the markets as well as to growing credit risk. Firms are now facing the second tightening of lending terms within just a few years. Once again the banks’ ability to assess creditworthiness correctly and not withdraw financial support from solvent, creditworthy customers will be crucial. Adequate and stable lending volume is essential to the banks themselves. In its first three-year refinancing operation on 21 December, the Eurosystem supplied banks with a total of €490 billion. Considering the contraction in the volume disbursed through other operations, the net increase in the resources provided to the banking system amounted to about €200 billion. This liquidity is circulating. Most of the funds re-deposited with national central banks did not come from the same banks that had obtained them from the Eurosystem. With this first three-year operation, Italian banks received gross funding of €116 billion, corresponding to net refinancing of €60 billion. The inflow of long-term liquidity substantially eased the funding tensions. The second three-year refinancing operation, scheduled for 29 February, will further sustain the supply of credit. The operations of the Eurosystem are currently on a full allotment basis; banks’ refinancing capacity accordingly depends on the availability of collateral. In recent months Italian banks have significantly increased the collateral pool at the Bank of Italy, to about €280 billion at the end of January. Their eligible uncommitted assets on the same date are estimated to have amounted to €77 billion after the application of haircuts. Since the total exposure to the Eurosystem amounted to about €200 billion, the Italian banking system’s capacity for further refinancing can be estimated at more than €150 billion. Following the recent decisions of the ECB’s Governing Council, we have joined other national central banks in announcing measures aimed at further expanding the range of assets banks can use as collateral for refinancing operations. In just a few days Italian banks will be able to deposit a broader range of bank loans meeting clearly defined eligibility criteria, with the Bank of Italy bearing the related risks. To reconcile the objective of increasing banks’ access to refinancing with the need to preserve the solidity of the central bank’s balance sheet, the new eligible collateral will be selected rigorously. In particular, it will include bank loans with a very low probability of default, not exceeding 1 per cent. As a result of the above changes, once haircuts have been applied, Italian banks’ total eligible assets will increase by another €70–90 billion to a little under €450 billion. This may permit a progressive reduction in the importance of government-guaranteed bank bonds, the volume of which is about €60 billion after the application of haircuts. The introduction of new collateral eligibility criteria and the ample supply of long-term liquid funds are helping to restore a uniform transmission of monetary policy in the various euroarea countries. BIS central bankers’ speeches The injection of three-year liquidity has already helped to attenuate the tensions on the money market. Compared with the days preceding the operation, three-month and one-year Euribor rates have fallen by about 40 and 30 basis points respectively, largely owing to the reduction in risk premiums. After rising to as high as one percentage point, the differentials between the overnight rates on the interbank markets of the countries most severely affected by the tensions and the euroarea average have fallen to zero. The spreads on credit default swaps for Italian banks have also fallen significantly, although they remain higher than they were up to the middle of 2011. At the end of January a large Italian bank returned to the international market with an issue of unsecured bonds that was favourably received by investors; the yield was not significantly higher than that on Italian government securities. 3. Banks’ profitability and capital strengthening In 2009 the financial crisis and the recession caused a sharp fall in Italian banks’ profits. In contrast with what happened in the other main European countries, the recovery in 2010 and 2011 was modest and the outlook for this year is not good. Banks’ profit and loss accounts are affected in the first place by the difficulties facing a large part of Italian industry. In addition to these cyclical problems, Italian banks are faced with others of a more structural nature related to the relatively limited diversification of their sources of income and the high level of their costs. Low profit margins reduce the resources with which to strengthen banks’ capital and make it more difficult to raise funds on the market, thus diminishing the ability of the banking system to support the economy. Profitability can be increased by improving the quality of the services supplied, thus permitting revenues to be expanded and diversified. The progress of technology and the public’s growing ability to use it can foster a rationalization of production processes and distribution networks; significant cost savings can also be achieved by simplifying corporate governance. The medium-term objectives for profitability must be revised taking into account the far-reaching changes that have occurred in recent years. Profit levels such as those seen in some parts of the international banking industry before the crisis are not compatible with the stability of the financial system. More efficient and stable banks can raise capital more cheaply. Basel III requires banks to operate with more and higher quality capital than in the past; in periods of rapid credit expansion it requires them to build countercyclical capital buffers; it sets a limit on their leverage ratio; and it introduces new liquidity ratios, so as to make banks’ balance sheets more resistant in the short term and better balanced in the medium term. Additional capital requirements are now planned for banks that could pose a threat to global systemic stability if they were in difficulty; effective and credible resolution mechanisms in the event of a crisis, including clear provisions on burden sharing, are likely to avoid costs being charged to the public or reduce them to a minimum. The new regulatory framework confirms the favourable treatment of loans to small and medium-sized enterprises already established by Basel II. In many cases such firms have opportunities to grow. Lending to well-capitalized firms deemed to be able to exploit economies of scale or scope carries lower capital charges for banks that use internal rating systems, so that loans can be granted at relatively low interest rates. In the years leading up to the crisis we saw just how damaging a race to the bottom between financial systems in both regulation and supervision can be. Therefore, when Basel III is transposed and implemented in the EU and in the other G20 countries, its objective of creating a level playing field for all banks must be fully respected. We have asked Italy’s leading banks to strengthen their capital considerably in recent years. BIS central bankers’ speeches They have complied, even in difficult times, mainly by raising funds, to a value of almost €20 billion, on private capital markets. Much ground has been covered in just a few years. The core tier 1 ratio of the five largest banking groups has reached an average of 9.5 per cent of risk-weighted assets, compared with 5.7 per cent at the end of 2007, on the eve of the crisis. The gap, now narrower, that remains between the capitalization of our leading banks and the average capitalization of their main foreign competitors partly reflects differences in the way risk-weighted assets are calculated in the various systems. Work to reduce these differences, which we strongly support, is now under way at international level and will include peer review mechanisms. In Europe, the adoption of the single rulebook will be a step in the same direction. When evaluating banks’ capital adequacy we also take account of their overall leverage. From this point of view, Italy’s banking system is extremely sound. The ratio of total balance-sheet assets to tier 1 capital of our leading banks is less than 20, against an average of 33 for the principal European banking groups. The Recommendation on banks’ capital issued by the European Banking Authority on 8 December as part of a broad package of measures approved by the European Council at the end of October aims to enhance the system’s ability to withstand the high sovereign risk tensions and potential additional shocks. It does not change the current prudential and accounting rules; it does not discourage investment in sovereigns as the capital buffer against sovereign risk relates to exposures at the end of September. The EBA’s Recommendation calls for a strengthening of capital, not a reduction of assets. The measure was decided in exceptional circumstances, necessitating a difficult trade-off between dispelling, firmly and promptly, any market doubts about the soundness of European banks and avoiding pro-cyclical effects. The EBA and the national authorities have repeatedly emphasized that the Recommendation is a temporary measure and will not be repeated. The EBA has decided to postpone the next stress test exercise on the European banking system to 2013. The optimal sequence for the measures taken by the European Council would have been to strengthen the EFSF and make it fully operational and to activate the system of European public guarantees for new medium- and long-term bank liabilities before or at the same time as the EBA issued its Recommendation. Had Europe’s intervention capacity been reinforced immediately, this would have reduced uncertainty over the course of the sovereign debt crisis in Europe and thus improved both the valuation of sovereign bonds and the banks’ ability to raise funds on the market. The EBA has agreed to re-examine the need for a sovereign buffer once the EFSF is up and running and sovereign bond prices are picking up. The Italian banks that took part in the EBA exercise can strengthen their capital base as required without reducing their lending to the economy. One leading bank has already successfully completed a large capital increase, which alone will cover nearly all its capital requirements and make good almost half of the Italian banks’ overall capital shortfall. The capital strengthening must proceed, however. We expect the banks’ forthcoming decisions regarding their dividend policy and executive compensation to take account of this. The Bank of Italy is about to issue guidelines to the banks in this regard. It is important that the banks prepare for the introduction of Basel III, which will be phased in between next year and 2019. Experience of recent years has shown that it is within the banking system’s capacity to achieve a reasonable strengthening of the capital base. BIS central bankers’ speeches 4. Banking competition and customer protection In a legal order that recognizes the entrepreneurial nature of banking, competition is the most effective means of protecting savings and safeguarding customers, to the benefit of the system’s stability. In addition to prudential supervision, the Bank of Italy is entrusted with tasks and responsibilities concerning transparency and correctness in bank-customer relations as regards banking products. In recent years we have significantly stepped up our commitment on this front. In the face of inefficiencies, it is necessary to shun the temptation to impose price caps or prohibitions on banks; however commendable the intent, these would merely scratch the surface of the problems, determining non-optimal pricing policies, impeding innovation and in some cases even reducing competition. Competition develops if the market is transparent, supply is diversified and switching costs are low – all necessary and mutually reinforcing factors. This is the thrust of the measures introduced by law in recent years: cost-free withdrawal from all contracts of indeterminate duration with banks, hence including current accounts; portability of real-estate mortgage loans; simplified procedures for transferring mortgages. The rules laid down by the Bank of Italy in exercising its powers of customer protection have the same thrust. We have demanded greater clarity and comparability of the information provided by banks, especially on the costs of their products. Measures have been introduced to make the costs of loans and current account overdrafts more transparent and comparable. Banks have been warned on more than one occasion that they must comply with the substance of these rules, and enforcement action has followed. Among the latest legislative measures, the prohibition on simultaneously holding corporate office in competitor firms is intended to prevent the risk of collusive conduct in boards of directors; the measures that favour the use of electronic payment instruments aim at reducing the use of cash, as in the other European countries; the terms and conditions applying to loans and breaches of overdraft ceilings will be more transparent. The Bank of Italy is in full accord with the spirit of these measures and is prepared to do its part for their implementation by rapidly overcoming any doubts of interpretation regarding the exact scope of some prohibitions. * * * The Eurosystem will continue to counter the malfunctioning of the markets and provide support to bank liquidity and lending. But to bring government securities prices back to levels consistent with the fundamentals of the euro-area economies, thereby eradicating the chief cause of the difficulties of the banking system, it is essential that national policies continue to be directed to stability and growth, which are not conflicting objectives, and that the reforms of European economic governance be implemented swiftly. The abundant liquidity made available by the Eurosystem in December and with the upcoming end-of-month operation, though not a cure in itself, is nevertheless crucial in the present phase. It has averted the imminent risk of an acute funding crisis with repercussions on credit and severely destabilizing consequences; it makes it possible to maintain a high level of financing for the economy. Banks will have to demonstrate that they are able to perform their credit allocation function well, under conditions of sound and prudent management, with keen discernment. Their very raison d’être demands it; it is essential that the economy not be starved of credit, allowed to waste away, dragging down the prospects of the banking system with it. At the same time, it is necessary to intensify the efforts to strengthen balance sheets and eliminate the structural problems that weigh on the efficiency and profitability of the Italian banking system. BIS central bankers’ speeches We firmly believe that we both can and must have confidence in the ability of our banks to rise to this challenge; and we are equally confident that an economic policy aimed at financial stability and directed to promoting an environment conducive to balanced growth will allow greater opportunities for investment and a rapid return to creating new permanent jobs. BIS central bankers’ speeches | bank of italy | 2,012 | 2 |
Concluding remarks by Dr Ignazio Visco, Governor of the Bank of Italy, at the Ordinary Meeting of Shareholders 2011 - 118th Financial Year, Bank of Italy, Rome, 31 May 2012. | Ignazio Visco: Overview of economic and financial developments in Italy Concluding remarks by Dr Ignazio Visco, Governor of the Bank of Italy, at the Ordinary Meeting of Shareholders 2011 – 118th Financial Year, Bank of Italy, Rome, 31 May 2012. * * * Ladies and gentlemen, I take the floor at this meeting for the first time in trying days for our country and for Europe. Days in which we must all – government, institutions and individuals – perform our roles with care, to the best of our ability, because only if everyone does their duty can a solution be found to the crisis we are experiencing. This is the spirit in which the consequences of the grave and tragic earthquake that has hit the region of Emilia must be tackled. As on similar occasions in the past, the Bank will not fail to provide assistance. The Concluding Remarks bring to a close the Bank of Italy’s Report, which every year covers the international and Italian economy and our own activities; in it we have deployed our analytical skills. Referring to the Report, I shall give an account, in particular, of the activities specifically entrusted to us: to contribute to drafting and implementing the common monetary policy, financial regulation and supervision. On 1 November last year Mario Draghi took up the post of President of the European Central Bank. He had been appointed Governor of the Bank of Italy by decree of the President of Italy Carlo Azeglio Ciampi at the end of 2005, at the culmination of a difficult period in the history of the Bank and of our financial system. During these years, his efforts, including in the demanding role of Chairman of the Financial Stability Board, brought prestige to our own institution and strengthened its reputation both in Italy and abroad. His direction was essential for the formulation of European monetary policy, for our supervisory action and for the modernization of the Bank’s organization and method of operation. The Board of Directors has appointed him Honorary Governor. The Bank of Italy and the country owe much to him. One of his first acts, in 2006, was to propose Fabrizio Saccomanni for the position of Director General. In that role Fabrizio supported him with his intelligence and his wide experience, participating in person in every major undertaking of the Bank, starting with the logistical and organizational reform of the head office and branch network. I wish to thank him for the invaluable contribution he has continued to make in recent months in running the Bank. The challenges we now face, and will continue to face together, are very demanding. We will devote all our abilities, our utmost efforts, to overcoming them in the interest of the Bank and of the country. In January, Salvatore Rossi, formerly Secretary General and before that Managing Director for Economic Research and International Relations, was appointed Deputy Director General, joining Giovanni Carosio and Anna Maria Tarantola on the Bank’s Governing Board. Our diverse experience, knowledge and aptitude contribute to the collegial nature of our activity. The Bank’s balance sheet shows total assets of €539 billion at the end of last year, 60 per cent more than the year before, partly as a consequence of the unconventional Eurosystem monetary policy operations we carried out. Thanks to the containment of operating costs, gross profit rose to €3.6 billion: €1.4 billion of this was transferred to the provision for general risks; €1.1 billion was paid in taxes; the Board of Directors allocated 40 per cent of the remaining €1.1 billion of net profit to the ordinary and extraordinary reserves and 60 per cent to the State. For a long time we have been working to improve the Bank’s organization, simplifying procedures, rules and work methods and making use of technological innovations. BIS central bankers’ speeches In 2011, a new strategic planning system, with a three-year time horizon, was put into effect. Our priority objectives are more effective internal and external communication, closer integration between operations management and information technology, and social responsibility. Specific action plans establish the timing of programmed interventions. The reorganization of the head office continued last year as well. A coordinating unit was set up to reinforce the Bank’s action in the field of financial stability. A new unit was formed within the Supervision Area, devoted to promoting the financial education of the public. The areas dealing with currency circulation, accounting and expenditure control have been re-examined. Together with the trade unions we have initiated a complex process of reform of staff positions, recruitment methods, personnel evaluation and career advancement, and compensation. Our aim is to move beyond a formal structure centred on roles and grades which, in a world of a radically new production and labour environment, no longer assigns proper value to human capital, specialist skills, tasks performed. I hope that discussions with staff representatives will be frank and constructive. The women and men who work in the Bank at every level and in every field are its lifeblood and its strength; it is to them that I express my deepest and most sincere appreciation and that of the Governing Board and the Board of Directors. The economy and monetary policy Since last summer Europe and Italy have been in the throes of an exceptionally serious crisis. After the worst effects of the financial crisis that had broken out in the United States four years before had been reined in with much effort, and financial assistance programmes had been drawn up for the euro-area countries in greatest difficulty with their public finances, banking systems and external accounts, for a year now new tensions have been present in the sovereign debt market. They were triggered not only by the deteriorating outlook for the global economy but also by the worsening of Greece’s financial situation and the fears caused by the announcement of the involvement of the private sector in reducing the country’s public debt. The tensions spread to the financial and banking markets of the euro area and had a direct impact on Italy and Spain. Sudden variations in private capital flows aggravated the payments imbalances of some European countries. The recovery in output was slowed down or reversed. Individual countries’ weaknesses have been underscored: in Italy, slow growth and the high public debt. The incomplete construction of the Union’s institutions weighs heavily on the market’s judgement. In Italy the yield on ten-year government securities jumped from 4.8 per cent in June to 7.3 per cent in November; the spread over German sovereign bonds reached 5.5 percentage points. The conditions for rolling over maturing debt in the winter months risked becoming prohibitive. Banks’ wholesale funding channels dried up: towards the end of the year their bond issues on international markets almost came to a halt. The tensions were reflected in the cost of funds and in the availability of credit. The flow of loans to firms slowed and turned negative in December. There was a serious and real risk of a large, persistent contraction in bank lending. The crisis was tackled on three fronts. The authorities of the most exposed countries made substantial corrections to their public finances and prepared structural reforms to foster growth, interacting with the European authorities; in Italy the actions initiated in the summer were completed and reinforced by the new Government. In the European Union the reform of governance was speeded up, the instruments for providing financial support to countries in difficulty were reinforced and banks were required to strengthen their capital bases. The Eurosystem intervened with very-large-scale extraordinary monetary measures. BIS central bankers’ speeches Notwithstanding some hesitation in carrying out interventions and defects in the sequence and effectiveness of decisions at European level, the loss of confidence was halted. In Italy the measures adopted in the autumn made a decisive contribution; the yields on government securities came down, by 220 basis points between the end of December and the middle of March. The tensions on the sovereign debt market have intensified again in the last few weeks, with the spread of new fears about the strength of the growth of the world economy and the possible emergence of a negative spiral between low growth, deteriorating public finances and problems with banking systems. The uncertainty about Greece after the general election has further strengthened the tensions. The spread between ten-year BTPs and Bunds is now back above 450 basis points. This has been due in part to the fall in German interest rates, which have been driven down by the search for safe haven assets. At the centre of the crisis there are now growing doubts among international investors about governments’ cohesion in guiding the reform of European governance and even their ability to ensure the survival of the monetary union. The economic situation has been deteriorating for a year. In Italy industrial production, which in the second quarter had with difficulty recovered less than half of the 25 percentage points lost in the recession of 2009, has fallen by 5 per cent since then. GDP has fallen for three consecutive quarters since last summer, contracting by a total of about 1.5 per cent. Unemployment has increased, rising from just over 8 per cent last July to nearly 10 per cent in March, and among young people under the age of 25 from 28 to 36 per cent. According to consensus forecasts, over the next two years as a whole the GDP of the euro area will barely grow. For Italy 2012 will inevitably be a year of recession, owing to the financial uncertainty and the drastic, but indispensable, measures to adjust the public finances. In scenarios that are not excessively unfavourable, the fall in GDP can be kept to about 1.5 per cent; an upturn could begin towards the end of the year and its likelihood will increase the more effective are the structural interventions to improve the use of public and private resources and the clearer and more determined is the cohesion shown by the European Union. Starting during the summer, the tensions in the sovereign debt market spread rapidly to banking systems. They were aggravated, with procyclical effects, by rating agencies’ successive downgrades of the credit ratings of both sovereign borrowers and banks. The segmentation of the interbank market along national lines became more pronounced, with a sharp rise in the spreads between the overnight rates on the Italian and Spanish markets and the euro-area average. Italian banks and those of other countries recorded a substantial reduction in their wholesale fundraising. In the last five months of 2011 the former’s net fundraising from non-residents, on foreign interbank markets and by way of bond issues, shrank by more than €100 billion. Investors feared that a contraction in fundraising, together with a possible lack of eligible collateral for Eurosystem refinancing, could trigger a systemic crisis. The tensions were intensified by the large volume of bonds maturing on international markets in 2012, amounting to nearly €450 billion for the euro area and €75 billion for Italian banks. The single monetary policy was in danger of not being transmitted uniformly; financial stability was at risk. The Governing Council of the European Central Bank reacted by extending its purchases under the Securities Markets Programme from the summer onwards, reducing the official interest rates in two steps and lowering the compulsory reserve ratio by half in December. It decided to carry out two refinancing operations, in December and at the end of February, with exceptionally long, three-year, maturities and full allotment. In addition, it extended the range of assets that could be used as collateral for loans. In the euro area as a whole the liquidity injected by the two three-year operations amounted to over €1,000 billion, or €500 billion net of the amounts maturing. In Italy 112 banks BIS central bankers’ speeches participated in the operations, receiving a total of €255 billion, or €140 billion on a net basis. The shortfall in wholesale fundraising was thus made good by Eurosystem refinancing; part of the resources obtained in this way was invested in government securities. In the aggregate, in view of developments in the economy, there was no increase in euro-area banks’ overall requirement for liquid funds. The liquidity created through the two three-year refinancing operations could not fail to translate into an equal increase in the amount of funds held with the Eurosystem’s deposit facility. But this does not mean that the liquidity remained idle: rather, it was re-deposited by different banks from those that had originally received it, after circulating among banks in different euro-area countries and taking the place of private capital flows where these had been interrupted. It preserved the orderly operation of the markets, kept yields down, and prevented the fall in fundraising from triggering a ruinous credit crunch for households and firms. In the last twelve months Italian banks’ loans to the private sector have increased by 1.3 per cent. Lending to businesses began to slow down in the spring of 2011 and contracted sharply in December, by more than €20 billion. It stagnated in the first quarter of this year and grew in April. The actual dynamics of lending has not been due to supply factors alone but also to cyclically weak demand and falling credit quality. Nevertheless, there are signs that the improvement in banks’ liquidity is helping to foster the supply of credit. In the first few months of this year, surveys of banks and firms reported some easing of lending terms with respect to the very critical conditions of the fourth quarter of 2011. On average, the interest rates on loans to firms turned downwards. Italian banks’ net purchases of Italian government securities, which had been modest or negative in the closing months of last year, amounted to €70 billion in the first quarter of 2012, about a third of it at maturities of less than a year. The liquidity of the market was partially restored. The banks’ build-up of short-term assets will enable them to cope with the possible failure to roll over their maturing bonds and to serve a recovery in the demand for credit. Re-establishing orderly credit market conditions is essential to the future growth of the economy. So far the rise in government security yields, banks’ fundraising problems, and the higher cost and reduced availability of credit to the economy have had a depressive effect on economic activity in Italy that is estimated at about one percentage point for 2012 as a whole. Without the Eurosystem’s interventions the effect would have been greater. Italian banks’ assets pledged as collateral for Eurosystem refinancing have increased by about €80 billion, thanks to the possibility, introduced at EU level in December, of obtaining government guarantees for bank bonds. The collateral pool deposited with the Bank of Italy, net of haircuts, reached €360 billion, €85 billion of which was unencumbered and promptly usable. Italian banks have an additional €100 billion worth of unencumbered eligible securities outside the pool. Moreover, the availability of eligible collateral may increase significantly as a result of the Bank of Italy’s measures making additional types of credit claims eligible, in implementation of the ECB Governing Council’s December decision. The Bank of Italy’s selection of the new collateral assets is subject to strict standards and controls, further refined of late. Hopefully, banks will adapt in order to take full advantage of this opportunity. The Eurosystem’s liquidity support measures were made possible by the credibility that its monetary policy had gained over the years and the stability of inflation expectations. The Governing Council’s decisions responded fully to the mandate of the ECB. It was essential to keep monetary policy from losing effectiveness and being transmitted unevenly in different countries. The brusque cessation of the flow of credit to the economy and the interruption of the orderly working of markets would have entailed extremely serious threats to financial stability. BIS central bankers’ speeches In Europe, the safeguarding of financial stability is entrusted to the regulatory authorities and the central banks. Macro-prudential oversight is the responsibility of the European Systemic Risk Board, within which the central banks play a leading role. The primary objective of the Eurosystem is to ensure price stability over the medium term; under the Treaty, it contributes to preserving the stability of the financial system. When financial stability is jeopardized, price stability itself is put at risk. Monetary policy cannot redress all the imbalances within the euro area, but it can stop contagion, avert systemic crises and ease tensions. Its contribution in sustaining markets and supporting liquidity remains essential. Today, an exit from the present policy framework would be absolutely premature. The financial system and the Bank of Italy’s supervision Since the outbreak of the crisis, Italian banks have made considerable progress in strengthening their capital. They have turned to the market in difficult circumstances. Since 2007 the core tier 1 ratio of the five largest banking groups has been raised from under 6 per cent to 10 per cent. For the other banks it has remained stable at around 10 per cent. Based on risk analyses, the Bank of Italy has invited banks to take the necessary steps to maintain or achieve capital ratios well above the regulatory minimum. The advance towards Basel III is on schedule. In these years the stability of Italian banks has been assured by a series of factors: low exposure to structured finance products; regulation and supervisory controls to prevent excessive risk-taking; low leverage by comparison with other banks in Europe; and a high proportion of capital instruments effectively capable of absorbing losses. Contributory factors were the absence of any real-estate bubble in Italy and the low level of household debt. However, the credit system is feeling the repercussions of two sharp recessions in three years and the sovereign debt strains. Credit quality has deteriorated. The new bad debt ratio on Italian banks’ loans to residents, which was less than 1 per cent in the years before the crisis, peaked at 2 per cent in 2009. The subsequent improvement came to an end in the second half of 2011 with the weakening of the economy, and the ratio went back up to nearly 2 per cent. There has also been an increase in substandard, restructured and overdue loans. For the most part the worsening of credit quality has involved loans to firms. By means of inspections and analysis of the information gathered from banks, the Bank of Italy exercises stringent control on the appropriateness of write-downs with respect to the actual prospects of recovering impaired loans. “Thematic” inspections of five medium-sized and large banking groups in 2011 found that management of the loans at greatest risk of deterioration was generally correct. Not many instances of protracted support to firms with no hopes of survival were found. Italian banks’ reference market consists largely of the domestic market of households and firms. In March 2012 their loans to customers resident in Italy amounted to some €1,950 billion, or 125 per cent of GDP. Deposits and bonds held by households, the most stable forms of funding, finance 85 per cent of lending. In the first half of the last decade the figure exceeded 90 per cent. The funding problems and the increase in risk premiums on the wholesale markets – the European interbank and international financial markets – make it necessary for banks to rebalance, with the requisite gradualness, the relationship between loans and stable sources of funding. Up to 2008 the expansion in loan volumes supported the growth in Italian banks’ revenues and profits, even if these were not especially high by international standards. Since then the decline in economic activity has led to a slowdown in lending and an increase in credit risk and the associated losses. Even excluding the huge write-downs to goodwill by some banks, exceptional and non-recurring events, profits in the last financial year were particularly low. BIS central bankers’ speeches In order to strengthen capital, self-financing must improve. But the current imbalance between lending and stable funding will make it difficult to return to a model of profitability growth based principally on expanding the volume of business. Vigorous action is needed to tackle operating costs, which have been relatively inflexible in relation to the state of the banking industry. The present level of labour costs is unlikely to be compatible with the prospective growth of the Italian banking system. The compensation of directors and top managers too must reflect the objective of containing costs. Ambitious strategies are needed to boost the efficiency of production and distribution significantly and capitalize on the contribution of new technologies. The widespread adoption of new modes of access to banking services calls for a rethinking of the economic viability of the entire distribution network. At the end of 2011 some 14.3 million bank accounts held by households and 1.7 million held by firms were enabled for on-line banking services, respectively five and three times more than a decade earlier. The number of bank branches grew by some 20 per cent between 2001 and 2008, and since then it has declined only modestly. Bank mergers and acquisitions have not been followed up by sufficient streamlining of groups’ organization or reduction in the number of board members. The ten largest banking groups have a total of 1,136 board positions, not counting foreign companies; bank subsidiaries alone have more than 700. The other intermediaries too often have overly large boards, which tends to make the individual members unaccountable and reduces board efficiency. Such arrangements are costly in themselves and are not justified by the professional expertise needed to effectively manage banks. The recent ban on interlocking board membership between firms in the financial sector is also an opportunity to modify the number of directors. The banks’ role in allocating resources has to be flanked by further development of the capital markets. For firms, a low proportion of equity capital and reliance on bank credit as the sole source of external finance constitute a factor of fragility in the short term and a drag on their growth potential. The difficulty that no few firms have encountered in accessing credit since the start of the crisis depends in part on their unbalanced financial structures, with excessive debt. Equity capital is the appropriate instrument for financing innovation. The incentives for increasing companies’ capital that are part of the Government’s pro-growth measures go in the right direction. Strengthening firms’ financial structure also necessitates changes in their relations with banks. In Italy 38 per cent of business loans are for maturities of less than twelve months, compared with 18 per cent in Germany and France and an average of 24 per cent in the euro area. Italian firms’ greater dependence on short-term debts exposes them to higher refinancing risk and restricts the time horizon of investments. Over half the short-term loans in Italy are in the form of overdraft facilities. The variability in the drawings on these credit lines exposes banks to liquidity risk; it is one of the characteristics that prevent their use as collateral for Eurosystem refinancing. The crisis has led to greater appreciation of the benefits of a more stringent regulatory regime, one able to avoid excessive recourse to leverage, volatile forms of funding and investment in assets far removed from banks’ credit function. It has shown that a high return on equity achieved through leverage is unsustainable and a source of instability. The new, more rigorous rules drawn up by the Financial Stability Board and the Basel Committee on Banking Supervision aim to reduce the risks of financial crises recurring. They may impose costs on economic agents and the economy as a whole, but they are aimed at preserving the basic functions of intermediation, which are essential to economic growth. Higher levels of capital reinforce banks’ stability, their capacity to supply credit even in BIS central bankers’ speeches difficult conditions. Consistency between capital endowment and asset risk is confirmed as a linchpin of the regulatory framework. Basel III comes into force next year. Two issues of fundamental importance in Europe are the definition of capital and the flexibility permitted to national authorities. The European Banking Authority must make sure that the capital instruments available to banks to protect against risks are defined in accordance with the reform. Allowing national authorities to impose conditions that are more stringent than the internationally harmonized requirements acknowledges the sometimes significant differences between banking systems. This needs to be accompanied by greater transparency and prior consultation at European level; the adoption of national measures must not jeopardize the smooth running of the single market. But rules alone are not enough. The Bank of Italy is working for the adoption of intensive and rigorous oversight and control practices. One element that is essential for guaranteeing systemic stability is the choice of method to measure risk-weighted assets, the denominator of capital adequacy ratios. Within the European Union there is wide dispersion of ratios of risk-weighted to total assets. The differences depend on balance-sheet composition and risk profiles; divergent supervisory practices also play a part. After the latest validations of internal models of risk measurement, for the five largest Italian groups the ratio exceeds 50 per cent, well above the European average. The peer review of the methods of calculating risk-weighted assets now under way within the Basel Committee and at European level accordingly needs to be completed without delay. The entrepreneurial nature of financial intermediaries must not be questioned. Government intervention limiting banks’ freedom to do business and market competition have generally entailed, including in Italy’s recent history, high intermediation costs and widespread distortions in the allocation of resources. The recent institution of the Credit Observatory could provide additional information on the financing of the economy. In performing its role of monitoring credit, the Observatory must not open the door to outside interference in banks’ assessments of customers’ creditworthiness. The Bank of Italy’s customer protection rules are based above all on the promotion of informed financial decisions, transparency of contracts and greater efficiency. The inclusion of standard information in the most common contracts and the use of synthetic cost indicators aim to make it easier to compare the various offers available. The banks must take steps to ensure that their organizations are focused on customers’ requirements. Special rules for payment services and consumer credit are designed to protect the weaker parties to contracts. If the banks themselves fail to take an approach that pays greater attention to cost control, the management of risks, including fiscal risk, and the protection of their customers, if they regard high-quality customer relations as a cost rather than a competitive tool, in the long run the results cannot be other than disappointing. The Bank of Italy is attentive to the need to ensure basic correctness in bank-customer relations. To this end, it has stepped up cooperation with the other authorities in the financial sector; it ensures the full functioning of the Banking and Financial Arbiter; and it has refined its oversight of intermediaries. The results of the checks and analyses performed, together with the continual flow of complaints from banking and financial customers, testify to the need for more vigorous efforts on the part of the banks. Controls on non-bank financial intermediaries have been intensified in the light of the widespread deterioration in credit quality. In this area too we are paying close attention to the formal and substantive correctness of relations with customers. The Bank of Italy is also entrusted with the task of preventing and combating the financial system’s involvement in money laundering. Provisions governing the organizational and internal control structures of intermediaries were recently adopted for this purpose. The BIS central bankers’ speeches banks have been called on to step up their efforts to block the infiltration of organized crime into the legitimate economy, which tends to intensify in times of crisis. The effectiveness of on- and off-site inspections has increased, and cooperation with the judicial authorities and Finance Police has been strengthened. The Financial Intelligence Unit, established at the Bank, has enhanced the effectiveness of its role as a junction between reports by intermediaries and investigations, to which it makes an active contribution. Europe and Italy If the euro area were viewed as a single entity, having, for instance, the form of a federal state, there would be no alarms regarding the resilience of its monetary and financial structure, notwithstanding the worries about the repercussions of the financial crisis on the economic cycle, banks and markets. But there is no political union in Europe. In the long term this makes monetary union more difficult to sustain; tangible progress must be made in the European construction; a path must be charted with political union as its ultimate goal, and each step marked along the way. As Tommaso Padoa-Schioppa observed on the eve of the changeover from the lira to the euro, “The danger lies in thinking that the euro is the final step, that united Europe is now fully forged. Those who wanted the single currency most, wanted it because it would facilitate further steps ahead, not because it would be the last one.” It is necessary to recall the original reasons underlying the European project, including in spheres that transcend economic activity. The economy of the euro area has now been integrated for some time; it counts over 300 million people and almost 20 million firms. Considered as a whole, it has external accounts in balance; an estimated public sector deficit and debt for the current year of just over 3 and 90 per cent of GDP, respectively; households with gross financial wealth three times their annual disposable income and debt equal to that income; and aggregate corporate financial debt equal to one year’s output. The numbers depict a solid and balanced economy, in many respects more so than other advanced areas of the world. European monetary union has confirmed economic integration in these years, giving it new impetus. The traditionally most virtuous countries have made a special contribution to the rest of the area: the example of sound policies, prudent on public expenditure, attentive to the needs of a structurally competitive productive system; and a basic national consensus on the objectives of price stability and social cohesion. They have benefited from a strong but not overvalued currency, from the absence of competitive devaluations, from a market larger than the national one and easily accessible. Countries such as ours that came from repeated bouts of inflation and currency crises have obtained stable prices and low interest rates, two basic prerequisites of economic development. We have taken little advantage of it. Political inertia, disregard of the rules and mistaken economic decisions have favoured the emergence of internal imbalances, long obscured by the euro and unheeded by the markets, which today put the entire European edifice at risk. We feel the absence of some of the fundamental characteristics of a federation of states: decision-making processes that favour the adoption of far-sighted policies in the general interest; shared public resources for financial stability and growth; rules that are truly accepted; and commonly agreed and timely measures for the financial system and banks. These are tasks and conditions that lie outside the sphere of the European System of Central Banks: they imply political responsibilities, both at national and European level. The Eurosystem and the European Central Bank cannot be called on to shoulder them; what they can do is fill temporary vacuums, contribute to policy analysis and design. In the last three years, driven by the tensions in the markets, significant progress has been made in reinforcing euro-area governance. But the decision-making processes, conditioned BIS central bankers’ speeches by the intergovernmental method and the principle of unanimity, remain slow and tortuous. A change of pace is required. In the immediate future, above all the need is for convergent manifestations of the unshakable will to preserve the single currency. If governments, the EU authorities, the European Central Bank itself, judge the progress of the troubled countries in financial restructuring and structural reform positively, this must be followed by a practical commitment on their part to orient the markets’ assessments in the same direction. The current yield spreads of government securities do not seem to take account of what has been accomplished: they fuel further imbalances, leading to a redistribution of resources from countries in difficulty to those perceived as sounder; they impede the correct operation of the single monetary policy; they are a source of risk to financial stability, an obstacle to growth. The instruments of financial assistance to states in difficulty must be made more effective in operational terms. There must be the possibility of intervening promptly in the securities markets and directly in favour of banks, with procedures that are more flexible and less penalizing for the beneficiary countries that respect the rules of the Union. It must be possible to make effective use of the significant resources already allocated by the member states. This is in the interest of all. Europe is also struggling with economic growth. The levers for reviving it are mainly in the hands of the national authorities, but the immediate launch of common co-financed investment projects, with particular attention to the weaker countries, could be an important signal to citizens and investors, who are currently concerned by the poor growth prospects of individual countries or regions. The availability of more common resources and also the constitution – proposed in several quarters – of a fund to which to transfer sovereign debt in excess of a uniform threshold, to be redeemed gradually according to a clearly defined calendar and procedures, are the substance of a form of fiscal union that cannot be uncoupled from cogent rules nor from powers of control and intervention. The moral hazard of counting on help from others so as to persevere in the bad policies of the past needs to be prevented by strong political and regulatory pressure, requiring the fulfilment of the commitments undertaken, on the basis of programmes that are ambitious but at the same time realistic. It is up to the countries in trouble to implement the reforms that will allow them to recoup competitiveness and reduce accumulated imbalances, within an appropriate timeframe and gradually but without the bar being lowered. It is up to the stronger countries to foster this process by not hindering rebalancing and by achieving structural progress that favours an expansion of demand. It is necessary to counter the dangerous tendency towards the renationalization of financial systems. In the first place, it is essential to avoid measures that, taken in good faith but from a purely national standpoint, effectively impede the workings of the single market and the single monetary policy. The transition to a uniform system of rules and oversight of the financial sector must be hastened, especially in the euro area. At the same time, consideration should be given to establishing common guarantee and insurance mechanisms, able to reassure savers and investors and to prevent panic and destabilizing flights of capital. Rapid progress in setting up a European fund to resolve banking crises would help to allay uncertainty in the markets. Italy has important tasks to perform. It has already begun to work on three different but interconnected fronts: a public sector that keeps its accounts in order, is not wasteful, and facilitates the economy; a sound and efficient banking system; and a productive system that is capable of innovating, competing and growing. The criticism that banks have failed to heed the needs of the economy is wrong: they are significantly exposed to households and firms that are creditworthy, albeit in difficulty: they can continue to sustain them. Beyond the short term, however, inconsistency between the BIS central bankers’ speeches level of lending and the stability of funding will inevitably have repercussions on credit activity. The supply capability of the banking system needs rethinking. At the same time, revised capital regulations, oversight and market practices are pushing the banks towards more careful risk control; they necessitate lower but steadier profits than in the pre-crisis decade. Bank shareholders need to realize this. It had been clear for some time in Italy that there was an urgent need for two necessary and inter-related economic policy actions: setting the budget on a sustainable and credible course and carrying out incisive structural reforms to revive the capacity for economic growth. The government has undertaken both. The first action, on the budget, has been rapid and decisive: according to current forecasts, this year the deficit will be well below the 3 per cent limit; next year it will be near structural balance and the public debt will begin to fall in relation to GDP thanks, in part, to the completion of the pension reform. There is a large and growing primary surplus; non-interest current expenditure has been falling in real terms for two years now. We have nonetheless paid the price of raising the tax burden to a level incompatible with rapid growth. This increase can only be temporary. The challenge now lies elsewhere: it is necessary not only to reduce tax evasion further but also to find spending cuts to counterbalance the reduction that must be made in the tax burden. If the cuts are identified with precision and based on equity, they will not prejudice growth; rather, if they eliminate inefficiencies in the public sector, simplify decision-making processes and curb administrative costs, they can stimulate it. The scope for reducing the public debt by selling assets in the public domain must be exploited to the full. The second action, for structural reform, has met with greater and more widespread resistance, but it has nevertheless achieved some important results. Work has begun on a vast scale and must be continued with increased energy and taking the broad view in fields ranging from education to justice and health. The task is to rationalize and prune the regulations and prevent total public expenditure from increasing. Yet spending priorities can be revised, the budget balance remaining constant, for instance in favour of education and research. The country can ask its entrepreneurs to make an extra financial effort to strengthen their firms’ capital when they benefit from a thorough streamlining of the regulatory and administrative environment. Investment will benefit, the real economy will be more robust, firms’ relations with banks will improve. Economic policy action can be undertaken serially, one matter at a time, but the overall design and the stakes must be clearly communicated and reasserted. Getting out of this tight spot will impose costs on all of us. They are bearable costs if they are properly shared and seen to have a clear purpose. The journey will not be short. Italian society cannot avoid confronting a changed world in which no position rents are allowed. At the same time, politics must ensure the prospect of a profound renewal that nourishes hope and responds to the aspirations of the younger generations. BIS central bankers’ speeches | bank of italy | 2,012 | 6 |
Keynote speech by Dr Ignazio Visco, Governor of the Bank of Italy, at the "Consiglio per le Relazioni fra Italia e Stati Uniti", Venice, 9 June 2012. | Ignazio Visco: Economic and policy interconnections in the current crisis Keynote speech by Dr Ignazio Visco, Governor of the Bank of Italy, at the “Consiglio per le Relazioni fra Italia e Stati Uniti”, Venice, 9 June 2012. * * * 1. The current crisis is a clear demonstration that in an increasingly interconnected global economy even local events can easily take on systemic, international importance. The crisis in the euro area originated in the financial debacle of 2007–2008, which was triggered by financial imbalances, regulatory failures and excessive risk-taking, mainly in the United States. Financial globalization has brought substantial benefits, such as more efficient intermediation of savings and risk-pooling, but it has also made the global system more vulnerable. The sovereign debt strains in the euro area reflect the impact of the financial crisis on some countries’ banking systems and public finances as well as pre-existing vulnerabilities, which for Italy consisted in slow growth and high public debt. Tensions were fuelled not only by the deteriorating outlook for the global economy but also by the worsening of Greece’s financial situation and the fears of contagion triggered by the announcement of the private sector involvement in the reduction of the country’s public debt. 2. If the euro area were viewed as a single country, it would appear as a sound and balanced economy. The external accounts are in balance. The public sector deficit and debt this year are forecast to be just over 3 and 90 percent of GDP, respectively. Households’ gross financial wealth is three times their annual disposable income, while their debt is equal to that income; aggregate corporate financial debt is equal to one year’s output. Italy’s figures are not far from the European average, and as regards the financial position of households and firms they are better. The external current account deficit is around 3 percent of GDP. The public debt is 120 percent of GDP but should begin to decline in 2013. In the absence of a European political union, the vulnerabilities of individual countries are magnified. Without the design and implementation of appropriate governance arrangements, monetary union is difficult to sustain. 3. Due to euro area’s openness and financial interconnections, the crisis can have world-wide repercussions. The area is more open than other advanced economies. Its trade with the rest of the world has increased noticeably, owing in particular to growing exchanges with new EU member states and the emerging economies. In 2011, euro-area exports and imports accounted for 49 percent of GDP, up from 32 percent in 1999; the corresponding figure for both the US and Japan is 29 percent. The area’s financial assets and liabilities vis-à-vis the rest of the world amounted to 184 and 196 percent of GDP, respectively, up from 92 and 99 percent in 1999. In the US the corresponding figures in 2010 were 140 and 157 percent. Italy is very open to foreign trade. Trade with countries outside the euro area is worth about 34 percent of Italian GDP and 6 percent of euro-area GDP. Including exchanges with the rest of the euro area, Italy’s openness is even more pronounced, the total value of foreign trade equalling 59 percent of GDP. The share of manufacturing exports in GDP is high compared to other advanced countries. In 2009 about 90,000 manufacturing firms – a fifth of all Italian manufacturers – sold part of their output abroad. Many are able to reach distant, difficult markets like China: this is the case for 8,600 Italian industrial firms, against 6,300 German firms and 4,200 French firms. In 2011, Italy’s foreign financial assets and liabilities amounted to 119 and 140 percent of GDP, respectively, up from 92 and 97 percent in 1999. 4. The crisis risks leading to re-nationalization of financial portfolios. The perceived risks are amplified by the uncertainty over the resolution of events that are in many respects BIS central bankers’ speeches unprecedented. The key is careful and timely analysis of each national economy and of the actors within them. The opportunities offered by financial diversification in a global environment are potentially intact. Ongoing reform efforts in the euro-area countries aim at preserving their attractiveness for financial diversification. °°° 5. The crisis has highlighted the weaknesses of EU and especially euro-area governance. First, the Stability and Growth Pact failed to provide sufficient incentives to correct fiscal imbalances. Second, budgetary discipline alone could not avert the financial tensions generated by macroeconomic imbalances. Third, the EU lacked a mechanism for managing systemic crises. EMU governance hinged on fiscal rules and a no-bail-out clause. The rules were deemed necessary because “the constraints imposed by market forces might either be too slow and weak or too sudden and disruptive” (Delors Committee, 1989). Economic convergence was expected to follow almost automatically from competitive pressures. But the fiscal rules were not fully enforced, macroeconomic imbalances mounted and markets behaved as expected: in spite of the no-bail-out clause, for years sovereign risks were underestimated; then they were overestimated. The crisis also made clear the close linkage between sovereign risk and bank risk. Before the crisis there was substantial convergence of interbank interest rates in the euro area and a significant reduction in the home bias of investors’ portfolios. Greater financial integration favoured uniform monetary policy transmission across the area. The crisis changed things dramatically. In the countries most severely affected by the sovereign debt crisis interbank rates increased to very high levels and wholesale bank funding became extremely difficult. Italian banks’ net fundraising from non-residents, on foreign interbank markets and by way of bond issues, shrank by more than €100 billion in the last five months of 2011. The huge volume of bank bonds maturing in 2012 and the difficulties that banks were encountering in accessing capital markets prompted fears that they might be forced to dump assets, triggering a potentially systemic negative spiral between declining asset prices, tighter lending standards and deteriorating economic conditions, which would jeopardize financial and price stability. Indeed, in the final part of 2011 the Eurosystem Bank Lending Survey signalled a sizeable tightening of lending conditions. There was the concrete risk of a ruinous credit crunch. 6. Policymakers responded in three ways: reform of European economic governance; ambitious programmes of fiscal consolidation and structural reform in member countries; and decisive actions by the Eurosystem to stabilize financial markets and preserve the monetary policy transmission mechanism. 7. First, the reform of the treaties and of the Stability and Growth Pact reflects recognition of the shortcomings of European governance. The first step was the creation of financial support mechanisms (the European Financial Stability Facility and the European Stability Mechanism), which permit the mobilization of substantial resources. The so-called “six-pack” and the “fiscal compact” reinforced the fiscal rules and strengthened enforcement mechanisms. Multilateral surveillance was extended to macroeconomic imbalances. The effort, though significant, is not complete. The fiscal compact awaits national ratifications. Proposals to further strengthen multilateral surveillance are still being discussed by the EU Commission, the Council and the Parliament. Financial assistance to states in difficulty must be made operationally effective. It must be possible to intervene promptly in the securities markets and directly in favour of banks, with flexible procedures that do not penalize countries that respect the rules of the Union. The progress of troubled countries in financial restructuring and structural reform must be accompanied by the undertaking of the European authorities to orient the markets’ assessments. BIS central bankers’ speeches At the same time, it is necessary to resist the re-nationalization of financial systems. Measures taken from a purely national standpoint could severely hamper the working of the euro area. We need to speed up the transition to a uniform system of financial sector rules and oversight. This should be accompanied by common guarantee and insurance mechanisms that can reassure savers and investors and prevent flights of capital. Rapid progress in setting up a European fund for the resolution of banking crises would help to dispel uncertainty. 8. Second, consolidation measures were implemented in a number of euro-area countries to restore the markets’ confidence in fiscal sustainability. To varying degree these interventions were accompanied by structural reforms to increase potential growth and avert a downward spiral of deeper recession and deteriorating public finances. In the case of Italy, action on the public budget has been rapid and decisive. Structural reform has met with more resistance, but some important results have nevertheless been achieved. Current forecasts put Italy’s budget deficit for 2012 below the 3 percent ceiling; next year the budget should be near structural balance and the public debt-to-GDP ratio should begin to fall, thanks in part to the completion of the pension reform. There is a large and growing primary surplus; current expenditure net of interest payments has been falling in real terms for two years now. However, the recent fiscal consolidation consisted chiefly of tax increases. This burden can be sustained only temporarily. A stronger and more incisive fight against tax evasion and the implementation of spending cuts are the indispensable premises for the necessary reduction of tax rates. If expenditure savings are targeted to removing inefficiencies and if they are equitable, they will not hamper growth but should stimulate it. On the structural front, in Italy more has been done since the summer of 2011 than during the previous decade. Work has begun on a vast scale with reforms to remedy the structural deficiencies that are holding the Italian economy back. Measures have been adopted in such crucial areas as competition and regulation, business environment, civil justice and infrastructure development. The reform of labour market regulation and the social safety net now in course of approval by Parliament aims at attenuating labour market dualism by altering the relative economic advantage of temporary over permanent contracts for firms; it also broadens the social safety net by widening unemployment insurance coverage. Competition-enhancing measures have been introduced in a good number of sectors. Some entail significant changes in the regulatory environment, whereas others have significantly less potential efficacy. Procedures for business start-ups have been streamlined, authorizations and ex-ante controls reduced. The administrative burdens placed on firms by environmental, labour, public procurement and privacy regulations have been reduced. As to the civil justice system, a geographical reorganization of the courts is under way to achieve economies of scale, while incentives for productivity have been introduced. Specialized courts have been instituted for some kinds of dispute involving firms. To promote infrastructure, administrative procedures have been simplified and measures taken to attract private investment. The actual impact of all these structural measures on the Italian economy will depend greatly on their full and effective implementation. It will take time for the effects to materialize. Systematic ex-post quantitative economic impact assessments are essential if the purposes of the reforms are to be realized. 10. The process of removing the obstacles to economic activity must be continued and strengthened. Undue restrictions to market competition have to be eliminated. The public sector requires sweeping modernization based on the evaluation of single units’ performance, reorganization, and further streamlining of regulations and administrative procedures. The fight against corruption and crime must be at the top of the agenda, also to minimize the costs that these two factors impose on the economy as they certainly form a significant obstacle to the efficient allocation of resources. BIS central bankers’ speeches Together with the fragmented nature of Italian industry, uncertainty over the enforcement of contracts (due to the slowness of civil justice), corruption and public sector inefficiency are taking a toll on foreign direct investment in Italy. In the last ten years FDI inflows (1.1 percent of GDP) have been much lower than those to France (2.5 percent) or to the euro-area countries as a group (2.3 percent). Reforms to make Italy’s economic environment more favourable to both domestic and foreign investment are needed to ensure the utilization of untapped human resources, especially young people and women, and to realize the growth potential of our southern regions. 11. Third, the Governing Council of the ECB reacted promptly with bold measures to counter the instability that emerged in the last part of 2011. The Council lowered official rates twice (to 1.0 percent), lengthened the duration of its full-allotment fixed-rate longer-term refinancing operations to three years, halved the compulsory reserve coefficient and expanded the range of assets eligible as collateral in refinancing operations. The two three-year LTROs carried out in December and February resulted in a net injection of liquidity of some €500 billion, which compensated for the shortfall in banks’ wholesale fundraising, averting the risk of a severe credit restriction and restoring more uniform monetary policy transmission. The abundant supply of liquidity and the greater availability of collateral strengthened investors’ confidence in banks’ ability to meet their funding needs, and market indicators improved. In Italy 112 banks participated in the operations, receiving a total of €140 billion on a net basis. Italian banks now have the resources to accommodate a recovery in the demand for credit, but the effects on actual credit growth will emerge only gradually, reflecting the usual lags. Much will depend on the evolution of economic conditions, which will affect credit demand and banks’ assessment of borrowers’ creditworthiness. °°° 12. The European and global economic outlook and financial market conditions are daunting. Uncertainty is very great. With the political deadlock in Greece and severe difficulties in the Spanish banking sector, tensions have re-emerged and sovereign spreads widened once again. The signs of faltering growth have intensified outside Europe as well, both in the advanced and the emerging economies. A new global economic slowdown would pose additional risks to already fragile financial systems and threaten the sustainability of public debts, in Europe and elsewhere. 13. At this juncture, support from monetary policy, both conventional and unconvential, remains essential. This week the Governing Council of the ECB confirmed its determination to provide all the necessary liquidity to the banking system and to preserve the functioning of the monetary policy transmission mechanism. In particular, our refinancing operations will continue to be conducted as fixed rate tender procedures with full allotment for as long as necessary, and in any case at least through the rest of this year. At the same time it is crucial to observe that the Eurosystem’s non-standard measures are temporary; they constitute a bridge that has yet to be crossed. A complete exit from the crisis will be achieved only if all actors properly shoulder their responsibilities. 14. The commitments of the G20 to boost growth must be pursued consistently. In the emerging economies, where there still is some fiscal and monetary leeway, policies should be geared to preventing an excessive slowdown. For the United States, it is essential to avoid the risk of a sharp fiscal tightening, such as would be produced in 2013 by the legislated automatic spending cuts and the expiry of earlier tax reductions. In Europe, the reform process must be reinforced at supranational and national level, in order to foster growth and correct both public and private structural imbalances. In particular, the reform of economic governance must be accelerated, in order to break the linkage between sovereign risk and bank risk. This will require courageous moves towards fiscal and financial union. Amendments to national constitutions may be necessary to shift some elements of BIS central bankers’ speeches sovereignty to the supranational level. The common resources made available by any such form of union should be complemented by cogent rules and powers of control and intervention. For Italy, the emergency is not over. Structural reforms, if seen within a consistent and comprehensive strategic framework, can provide the basis for a surge in confidence in our potential for sustained economic growth. Preserving and sustaining fiscal responsibility is essential, even if at the cost of some short-run difficulties. BIS central bankers’ speeches | bank of italy | 2,012 | 6 |
Panel discussion remarks by Mr Ignazio Visco, Governor of the Bank of Italy following the Per Jacobsson Lecture by Dr YV Reddy, 24 June 2012, Basel, Switzerland. | Ignazio Visco: What does society expect from the financial sector? Panel discussion remarks by Mr Ignazio Visco, Governor of the Bank of Italy following the Per Jacobsson Lecture by Dr YV Reddy, 24 June 2012, Basel, Switzerland. * * * The global crisis has spotlighted a number of problems. Some are well known (eg the fact that in some countries in the past the regulatory and supervisory approach was inadequate to address them). Others are relatively new. A comprehensive overview of the many issues facing public authorities has just been provided by Dr Reddy, with a thorough checklist of what has gone wrong, what is being done, and what direction we should probably be moving in. I would like to focus on a more limited set of issues, which in my view are among the most telling about the weaknesses of the financial system today. First, however, let me recall that although the title of our roundtable is “What does society expect from the financial sector?” we are likely to only be able to discuss what we think society “should” expect. With this in mind, I would like to make three points: ● Finance has long been viewed as a morally dubious activity. My appeal to authority on this matter is a reference to a lecture delivered by Amartya Sen about twenty years ago as the first Paolo Baffi Lecture (Money and value: on the ethics and economics of finance, Bank of Italy, Rome, 1991). Sen wondered: “How is it possible that an activity that is so useful has been viewed as being morally so dubious?” He recalled a series of historical episodes: Jesus driving the money lenders out of the temple, Solon cancelling debts and prohibiting many types of lending in ancient Greece, Aristotle describing interest as an unnatural and unjustified breeding of money from money. Recent protests against the financial industry – the Occupy Wall Street movement, the “Indignados” in Spain and their counterparts in other European countries – can certainly lay claim to an eminent series of historical precursors. ● Superimposed on this “structural” mistrust, one can detect cyclical patterns in the public’s attitude towards finance, affected by the conditions of financial systems and shifts in the political mood about state intervention in the economy. Until the 1970s it was taken for granted that market failures required the presence and response of a regulator to avoid suboptimal results. Then came the great inflation of the 1970s, combined with high unemployment, and the accent began to be placed on government failures. Governments, central banks and other regulators were blamed for failing to prevent those developments. This eventually led to an ideological swing: a push to reduce the magnitude of state intervention. The failures of the “regulated economy,” the pace of technological advance and the rapid expansion of international trade after the end of the Cold War fuelled a protracted process of financial deregulation that was halted only by the financial crisis that broke out in 2007. The latter triggered a move toward re-regulation – or better regulation – that is still under way. The pendulum keeps swinging and will certainly continue to do so. ● But despite the negative perception of banking and finance, blind backlash is a danger to be avoided. As Amartya Sen argued, finance is essential to the functioning of the real economy. And I share Dr Reddy’s view that finance is a force for good. It is crucial for sharing and allocating risk, especially for poorer societies and people, insofar as risk aversion decreases with wealth. It is crucial for transferring resources over time and removing the liquidity constraints that hamper the economy and the exploitation of ideas. It is very important in promoting economic growth, especially by fostering innovation. We have countless historical examples of good financial innovations. Think, for example, of the “letters of exchange” introduced by Italian merchants in the Middle Ages: they were probably the first fiduciary money, and trade benefited enormously from this financial instrument. More recently, consider the development of “micro-finance” in the 1970s: an innovation that has enhanced financial inclusion, helping poor borrowers to smooth their income and cope with illness or other temporary shocks. And, in the last two decades, recall the role of the “venture capital” industry in the promotion of successful innovative corporations such as Apple, Intel and Google. I would now like to offer a few thoughts on issues related to what has gone wrong in the financial system in the last few decades. I will consider four points: ● Financial market participants tend not to be aware of the fundamental nonstationarity of economic developments. The wave of financial innovation in the 2000s was fuelled by the idea, in principle correct and fruitful, that the proliferation of new (and complex) financial instruments, allowing agents to insure against many dimensions of risk, was a way to “complete the markets”, to get closer to the theoretical Arrow-Debreu world, enabling investors to transfer resources efficiently across time, space and states of the world. But this idea relied on the presumption that the world is basically stationary (and substantially linear), that the future is pretty much like the past, that we can extrapolate from relatively small samples, and that there is a single “data generating process” that we can identify and understand. (We must admit that all this is not limited to finance but also applies more broadly to macroeconomics, econometric modelling and forecasting.) The real world is different, though; for many years the big investment banks were able to sustain returns much higher than what was justified by economic growth, but the day of reckoning was bound to come. In a way, innovation, based on the presumption of stationarity, sows the seeds of the non-stationarity that eventually undermines that very presumption. ● Complexity was also used, somewhat perversely, as part of the case for a sort of benign neglect on the part of regulators. The big financial players argued successfully that financial innovation was too complex and too opaque for the regulators to get their heads around it. Indeed, they said, to safeguard the international financial system from systemic risk, the main priority was promoting an “industry-led” effort to improve internal risk management and related systems. This, in a nutshell, was the view espoused by the Group of Thirty report following the outbreak of the Asian crisis (“Global institutions, national supervision and systemic risk”, Group of Thirty, 1997. See also the article by John Heimann, and comments therein, in the special issue of the Banca Nazionale del Lavoro Quarterly Review on “Globalization and stable markets”, March 1998). But this thesis was often accompanied by the argument to the effect that “you, regulators and supervisors, will always be behind financial innovation; it would be better to allow us, the big financial international players, to self-regulate; we are grownups, we can take care of ourselves”. And, after all, “if someone makes mistakes, some will gain what others lose; why can’t we be left alone to play this zero-sum game of ours?” Accepting this argument was a critical mistake. The regulators did not, in fact, have either the right incentives or the ability to acquire the necessary information, for two reasons. First, the big financial players are global, and national regulators had powers too narrow to be able to confront them. The difficulties in coordinating the regulators’ actions, in the face of a natural tendency to preserve each one’s particular sphere of influence, was a powerful drag on the ability to rise to the challenge posed by a finance gone global. Second, the phenomenon of regulatory capture that Dr Reddy mentioned in his talk was a definite reality. Powerful political and economic influences were at play, and in some cases prevailed. ● Other factors that have now become well known were the financial industry’s remuneration policies and incentive structure, which ultimately induced excessive risk-taking and short-termism. (On these attitudes, I would like to recall the pertinent insights of Tommaso Padoa-Schioppa and Andrew Crockett at the last two Per Jacobsson lectures.) Significantly, compensation structures that favour risk-taking are correlated with banks’ default risk. Of course this may be useful to attract managers with low risk aversion, which may be a desirable trait for financial intermediaries. But from the systemic perspective, default by a bank generates costs that do not fall entirely on its shareholders, so that the “optimal policy” from the bank shareholders’ standpoint may be very suboptimal for the economy overall. While this state of affairs benefited the “whole” financial industry, it may also have led to a possibly serious misallocation of resources. We may now be observing a reversal, with an outflow of highly skilled people from the financial industry. Whether this is desirable or not depends on one’s view of externalities, and on the costs that a less efficient financial sector may have for society. After all, social returns might be higher in other occupations. Anyway, a reduction in salaries in the financial industry may reduce the potential skill gap between the industry and its regulators. The regulatory agencies may become better able to attract highly skilled financial workers, improving the effectiveness of their regulatory and supervisory activity. ● Finally, there has been a change in the relative importance of the various banking activities. In particular, proprietary trading has expanded very significantly. Interestingly, the cost of financial intermediation has been trending upward in the past 40 years. This is counterintuitive, given the technological advances in information and communication technologies, which should have disproportionately increased efficiency in the financial industry. It is likely that the technological advances have mostly been internalised by the industry itself and deployed to increase secondary market activities, in particular proprietary trading. Over the last few years the crisis has heightened appreciation of the benefits of a more stringent regulatory regime. And much has been done to remedy the shortcomings of financial systems. At the international level, under the political impulse of the G-20, the Financial Stability Board and the Basel Committee on Banking Supervision introduced substantial regulatory changes to reduce the frequency of financial crises and increase the resilience of economic systems. Improvements have been introduced in many areas such as bank capital and liquidity, OTC market infrastructure, and compensation policies in finance; importantly, new macro-prudential authorities have been established in many countries. But the regulatory overhaul has not yet been completed. Several issues are still being actively discussed, such as the role of rating agencies and accounting standards. Although new regulations on systemically important financial institutions have recently been approved, the “too-big-to-fail” issue is still a major concern. It would be foolish to pretend that defaults can be avoided, so we need to be prepared for their occurrence. The ongoing work on resolution regimes is a promising approach in this regard. Rules alone are not enough, however. Allow me to mention a few scattered areas from which progress should be expected: ● One element that is essential for guaranteeing systemic stability is the method of measuring risk-weighted assets (RWA), the denominator of capital adequacy ratios. RWA measures have recently attracted increasing attention from market analysts, banks and supervisory authorities. It has been argued that the methodologies for computing RWA may not be comparable across institutions and, especially, across jurisdictions, and that they should more properly reflect risk in order to avoid ultimately jeopardising financial stability. These problems highlight the relevance of supervisory practices in determining banks’ capital requirements (for example, in validating internal banks’ models for calculating risk weights). Here, rigorous microprudential supervision is essential. We really need to work out a single rulebook, to move with determination towards taking joint responsibility and using peer reviews as much as possible in our supervisory activity. The watchword can only be: “more and better supervision”. ● Furthermore, in today’s globalised world, it is crucial to make sure that countries cooperate and agree on the appropriate stringency of financial regulation. Countries should not compete by relaxing rules in order to attract financial intermediaries, as this may generate negative externalities for other countries. This is a most delicate issue, and while a perfectly level playing field may not be achievable, we have to be conscious of the consequences of a “beggar-thy-neighbour” approach to regulation. The transition to a uniform system of rules and oversight of the financial sector must be hastened. In the euro area, and in the European Union at large, the project for banking union is ambitious, but it goes in the right direction. ● Let me close on a different but related topic. Some countries are now investing increasingly in efforts to improve the financial literacy of the public. This too is important. On the one hand, it helps to build the demand side of the “inclusive finance” that Dr Reddy mentioned, while on the other, financially literate citizens are better able to understand the efforts of regulators and policy makers to improve supervision and regulation, and less likely to subscribe to the simplistic view that “finance is evil”. But we should realise that – as the case of Bernard Madoff and others in the US and elsewhere clearly show – this is no panacea. (Madoff’s customers were surely much better educated than the average.) Therefore, for purposes of consumer protection in the financial services industry, financial regulation and good supervision are the necessary complements to financial education and inclusion. To conclude, following Dr Reddy’s final remarks, I would like to quote from a book by the brilliant Bank of Italy economist Curzio Giannini, who passed away prematurely nine years ago (The age of central banks, Edward Elgar, 2011, translated from the Italian L’età delle banche centrali, Il Mulino, 2004). In that “beautifully written and illuminating” work, as Charles Goodhart describes it in his foreword, Curzio applied “a theory of history” to describe how from pre-industrial payment technologies through the rise and fall of convertibility we ended up with the revolution in the payment system that has accompanied the globalisation of money and the challenge of building trust in an under-institutionalised environment. Already at the turn of the century, Curzio clearly saw the likely consequences of financial developments, and concluded, “In the years to come, the most interesting developments will probably be precisely in the sphere of supervision and regulation” and that “[w]hatever its detractors may say, the central bank has no need to move into new lines of business. Capitalism generated the central bank and capitalism will come to it again, even if the current infatuation with the financial markets’ self-regulating capacity were to endure. […] The central bank produces an intangible but essential good – trust – of which capitalism has an immense need. We must not forget that trust, or its synonym “confidence”, derives from the Latin fide, meaning faith, which cannot be produced simply by contract. In fact the legitimacy of central banks does not lie in their policy activism, or the ability to generate income, or even, save in a highly indirect sense, their efficiency. Rather, […] it derives from competence, moderation, the long-term approach, and the refusal to take any tasks beyond their primary role.” In the end this, perhaps, is what society should expect, if not from the financial sector, from those who are called to look after financial stability. | bank of italy | 2,012 | 7 |
Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the Annual Meeting of the Italian Banking Association, Rome, 11 July 2012. | Ignazio Visco: Brief overview of the Italian economy and its banks Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the Annual Meeting of the Italian Banking Association, Rome, 11 July 2012. * * * The sovereign debt crisis and the Italian economy The Italian economy is still in recession. The consensus forecasts indicate that Italy’s GDP will decline by nearly two percentage points in 2012 as a whole. The increase in the cost and the deterioration in the availability of credit following the sovereign debt crisis have contributed to the worsening of the situation. The difference between the yields on Italian and German government securities is far greater than could be justified by our economy’s fundamentals. It reflects general fears of the monetary union breaking up – a remote possibility but one that is nevertheless influencing the choices made by international investors. The decisions taken at the euro-area summit of Heads of State and Government and the European Council of 28–29 June, and clarified in last Monday’s Eurogroup meeting, underlined the will to preserve the single currency and to break the vicious circle between the sovereign debt crisis and the situation of the banks. To properly orient the markets’ judgment concerning the progress made by the member countries in fiscal adjustment and structural reform, the resources of the European stabilization funds, the EFSF and the ESM, must be put to the best possible use, including the containment of funding costs within limits that are consistent with the fundamentals of the different economies. We must continue to strengthen the European construction, advance towards a true federation, and lay the foundations of a fiscal union in which national sovereignties will end at the point where the sharing of resources and responsibilities begins. The common currency can only be a lasting source of stability and progress if it rests on these foundations. A single system of banking supervision is necessary in an integrated financial market such as the euro area; the presence of large banks operating in several different countries requires uniform rules and controls, so as to eliminate duplications and local differences and pursue the stability of the European banking system as a whole. European supervision should be defined as a single, mutually supportive and independent system, in which decisions are taken collectively and implemented at the appropriate level, based on the experience and expertise of the national supervisory authorities. A fully-rounded plan requires that a single banking supervision system be flanked by the introduction of European funds and mechanisms to protect depositors and resolve crises, with the necessary prerequisites for tax sharing; otherwise, the credibility and sustainability of the system would be called into question. The reduction of the official interest rates to an all-time low, decided on 5 July, reaffirmed the determination of the ECB Governing Council to ensure that monetary conditions are appropriate to the economic and financial situation of the area. This is an important decision; it follows on from other measures adopted last month to continue to guarantee the necessary liquidity for the banking system and to counter the effects of the segmentation of the money and financial markets within the area, which is an obstacle to the uniform transmission of the single monetary policy. The ECB cannot but continue to act for these objectives. Italy must continue the work it has already begun on two fronts: the public finances and structural reform; it must be prepared to seize the opportunities offered by the stabilization of financial market conditions. The crisis has impelled us to address the problems that have bridled our economy for so long. This task was put off for far too long, following the advent of BIS central bankers’ speeches monetary union, at the cost of a progressive loss of competitiveness and a gradual deterioration of the public finances. We must make our economic environment propitious for enterprise, eliminate waste and make the public administration more efficient. Italian banks must accompany this effort. Low financial leverage, the emphasis on the traditional banking business of deposit-taking and lending, and the absence of any housing bubble have shielded them from the impact of the global financial crisis that began five years ago. They have been able to maintain financial assistance to solvent, creditworthy customers. To continue along this road, now that strong sovereign debt tensions making themselves felt, banks must increase their capital endowments and strengthen their management of credit and liquidity risk, proceeding along the path already taken. The activity of Italian banks Since the middle of last year, with the cyclical downturn, the quality of business loans has worsened. The flow of new bad debts on loans to non-financial firms, which between 2005 and 2007 had been steadily below 1.3 per cent of total outstanding lending, rose to 2.9 per cent in the first quarter of this year, 0.2 percentage points higher than at the end of 2011. For households, by contrast, during the same period this indicator fell by 0.2 points to 1.2 per cent. Loans classed as substandard, restructured or overdue increased. At the end of 2011 the stock of bad debts amounted to 6.2 per cent of total loans to non-bank customers, nearly a full percentage point more than a year earlier. For the top five banking groups the bad debt ratio was 6.9 per cent, for the other banks 5.0 per cent. The stock of impaired positions (bad debts and substandard, overdue and restructured loans) was equal to 11.2 per cent of total loans to non-bank customers at the end of 2011, this too representing an increase of about one percentage point in the year. International comparison of the balance-sheet incidence of impaired loans is distorted by cross-country differences in practices. The Italian definition of the aggregate is broad, including assets that are still generating income. Moreover, the slowness of legal proceedings for credit recovery in Italy means bad debts remain on the balance sheet longer, thereby raising the level recorded in the accounts. In any case, having a large share of impaired claims in balance sheets puts pressure on banks’ capital and liquidity. The first safeguard against the risk of deteriorating credit quality is effective borrower screening based on objective criteria, robust valuation models and optimal utilization of the information available to assess customers’ prospects. During the first half of 2012 the Bank of Italy conducted targeted inspections of credit risk at 14 intermediaries that account for 59 per cent of lending by Italian banking groups. The inspections examined the banks’ procedures and controls during the granting of loans, the adequacy of their internal risk measurement models, the quantification of risk assets, and the adequacy of their provisioning policies. The new rules on related-party transactions, which will be fully in effect by the end of this year, will help to strengthen credit quality and foster greater impartiality in the allocation of credit. The bad debt cover ratio – the ratio of value adjustments to exposures – declined last year from 57.2 to 55.7 per cent. This is higher than in the early 1990s but lower than the ratio registered before the outbreak of the financial crisis. In times of recession, when bad debts increase more rapidly, such a decline is normal, at least in part, but banks’ value adjustments for deteriorating credit quality (which were equal to €18.4 billion in 2010 and €19.3 billion in 2011) must continue to grow. Even during the present phase the increase in provisioning can be funded out of banks’ ordinary earnings. Effective policy for provisioning not only strengthens balance sheets but BIS central bankers’ speeches can also favour the liquidation of impaired assets. Suitable ways of reducing their weight on balance sheets must be devised. The increase in sovereign risk has hampered our banks’ wholesale funding. Total fund-raising, net of Eurosystem refinancing, shrank by 4.6 per cent in the twelve months through May, reflecting a contraction in funding on international markets. The Eurosystem’s two longer-term refinancing operations compensated for this shortfall and averted liquidity strains. By contrast, retail funding provided by savers resident in Italy has not been affected by the crisis. In May bank deposits were 1.2 per cent greater than twelve months earlier. The current slow growth in lending depends in the first place on the slackening of demand due to the recession. A brusque tightening of credit supply owing to the wholesale funding strains and the deterioration in loan quality was observed at the end of last year. Supply conditions improved in the early months of 2012 thanks to Eurosystem refinancing. New strains have emerged in recent months in connection with the instability of the markets. The three-month rate of change in bank lending to firms was slightly negative in May, while credit to households remained stable. The more stable forms of fund-raising – deposits and bonds subscribed by households – are sufficient to finance over 80 per cent of Italian banks’ lending, more than at the end of 2011. Banks need to continue their pursuit of a structural rebalancing of sources of funding. The technical forms of credit must be evaluated with care. The share of total lending consisting of current account overdrafts is 28 per cent in Italy against an average of 12 per cent in the rest of the euro area. This method of supplying credit to customers exposes banks to liquidity risk, makes cash outflows less predictable, and hampers the formation of eligible collateral for Eurosystem refinancing. More attentive management of liquidity by firms could foster a reduction in recourse to overdrafts. The strict liquidity requirements for banks introduced by Basel III represent a necessary prudential safeguard of stability. The rules need to be fine-tuned to avoid potential pro-cyclical effects. In particular, the liquidity buffers built up during periods of expansion must be effectively usable in times of difficulty. The disincentives to the circulation of funds through the interbank market must be eliminated. The risks of wholesale banking business have to be more clearly distinguished from those of retail intermediation. Capital endowment and cost containment Italian banks have been making progress in strengthening their capital for some time now, partly at our request and despite the difficult market conditions. Between the period before the crisis and March of this year the banks’ core tier 1 capital increased from 7.1 to 9.9 per cent of risk-weighted assets. Since the beginning of 2011 the five largest banking groups have increased their capital through recourse to the market for a total of over €17 billion and by restructuring convertible bonds as core tier 1 capital worth a further €3 billion; their core tier 1 ratio now stands at 10.0 per cent. The average capital ratio of the remaining 66 groups has risen to 8.7 per cent. The capital of the other 472 institutions not belonging to a group, for the most part mutual banks, amounts to 13.7 per cent of risk-weighted assets. The five largest Italian banking groups now comply with the capital target set by the European Banking Authority (EBA), which asked banks to increase their core tier 1 capital taking into account sovereign risk exposure. The EBA’s exercise set their total capital needs at €15.4 billion, more than 70 per cent of which has been covered by means of privately subscribed capital increases and self-financing. The reduction of risk-weighted assets as a result of more widespread use of internal models, carefully evaluated by the supervisory BIS central bankers’ speeches authorities, has also contributed. We examined the measures proposed by the banks with the specific aim of preventing any significant contraction in lending to the economy. Public intervention was needed in the case of Banca Monte dei Paschi di Siena owing to the pronounced tensions affecting the financial markets, which made the cost of new issuance prohibitive, and the difficulty of making asset disposals in very strained market conditions. Achieving the same target by alternative means would have entailed a reduction in lending to the economy. Even with this operation, the total amount of government intervention in support of the Italian banks is still low by international standards. This also reflects the low level of trading in opaque and risky financial instruments. From 2008 to 2010 government aid disbursed to European banks for recapitalization and coverage of losses amounted to €409 billion, or 3.3 per cent of GDP; the guarantees utilized for new issues of debt totalled €1,111 billion (9.1 per cent of GDP). In Italy, equity transactions amounted to €4.1 billion or 0.3 per cent of GDP, and the banks required no guarantees. Including approved state financial assistance, for which figures are available up to the autumn of 2011, the value of government measures in Europe has now risen to 37 per cent of GDP; however, this does not take account of the latest recapitalization measures in favour of some European banking systems or of the guarantees given in respect of bank liabilities. In Italy, such measures are of limited magnitude: specifically, the additional capital increase for Banca Monte dei Paschi di Siena will amount to around 0.1 per cent of GDP, while the guarantees attached to bonds used as collateral for Eurosystem refinancing currently total 5.5 per cent of GDP. The progress achieved in capital strengthening must now be consolidated. On the basis of analyses calibrated according to the intermediary’s exposure to the different types of risk, we have asked banks to further raise their higher quality capital above the regulatory minima. The new rules on capital are one of the pillars of the Basel III reform. In Europe, their adoption will mark a turning point. The Bank of Italy continues to uphold the importance of properly implementing the regulatory provisions already agreed by the G20. It would be a grave error to undermine the reform approved at international level. The markets would punish such a decision. As a result of the capital operations conducted in the early months of this year, including those in connection with the EBA’s recommendation, the capital needed by Italian banks in order to comply with the new common equity requirements that will apply when Basel III comes into full operation has been significantly reduced. About 60 per cent of the capital increase still needed can be put down to the fall in the prices of sovereign securities from the second half of 2011 on. Under the new prudential requirements all capital losses directly affect regulatory capital. Italian government securities represent about one tenth of the assets of the country’s banks. A decline in their yields from present levels will make it easier for the banks to comply with the new prudential requirements. Compared with the phasing-in envisaged for Basel III, the European rules (not all the main aspects of which have been finalized yet) allow the accelerated application of all or part of the new capital regulations. The markets apparently already assume that the core tier 1 capital ratios will be on the order of 7 per cent (the minimum of 4.5 per cent plus the 2.5 per cent capital conservation buffer). The change-over to the new system must nonetheless be promptly and clearly prepared by banks and authorities working together. Ensuring the soundness of banks necessitates that national supervisory authorities apply rigorous criteria in assessing risk-weighted assets (the denominator of capital ratios). Italian banks’ ratio of risk-weighted assets to total exposures is high by international standards. BIS central bankers’ speeches For global systemically important banks, the higher capital levels approved by the G20 and crisis management measures will strengthen their ability to absorb losses and will limit how far banks are interconnected and the risk of contagion among intermediaries and between finance and the real economy. On 29 June the Basel Committee began a public consultation on its proposed principles to ensure that domestic systemically important banks too are endowed with a high capacity to absorb losses. Compared with the rules for the global systemically important banks, the national authorities are given more leeway to determine which intermediaries are subject to additional loss absorbency requirements and to calibrate capital requirements. Implementation of the principles will be subject to peer review. For cross-border groups, it is envisaged that host supervisors may establish additional requirements if the subsidiary is systemically important; reflecting a position we argued for vigorously in the international discussion, the principles recognize the need for robust mechanisms of coordination between home and host authorities in order to avoid measures that could harm the integration of financial markets. In a phase of weak growth in the volume of business, heightened tensions on the financial markets and mounting credit risk, a recovery of profitability must be sustained by gains in efficiency. As I have remarked on other occasions, strategies to improve production and distribution processes, to exploit the contribution of new technologies in full, must be rapidly put into practice. In the first quarter of this year the operating costs of the five largest banking groups declined in relation to gross income. Operating profitability consequently benefited. The action undertaken to curb costs must continue. Banks must rapidly rationalize supply structures. Compensation policies too must be aimed at the objective of reducing costs. The main Italian banks have made progress since March 2008, when the Bank of Italy issued its first supervisory instructions on compensation: the total pay of top management has declined in the last two years; bonuses have diminished. Cost containment is still not widespread enough among medium-sized listed banking groups, nor has it involved all the top positions. At a number of institutions the compensation of top management is fixed, not tied to the bank’s performance over a number of years. Non-executive directors, who often hold multiple positions within the group, have received increasing compensation in line, on average, with that of general managers. The Bank of Italy also expects the banks to reduce the size of severance packages: overly generous benefits impinge on prudent management and the proper functioning of governance mechanisms. The communication addressed to the banks on 2 March reiterated the need, in the current cyclical conditions, to align the pay incentives of directors and managers with the risks taken, to make them consistent with a policy of strengthening capital and curbing costs. The protection of consumers of banking and financial services The Minister for the Economy and Finance, in his capacity as Chairman of the Interministerial Committee for Credit and Savings and acting on a proposal from the Bank of Italy, recently issued the decree implementing the new provisions of the Consolidated Law on Banking concerning fees for overdrafts and overrunning. The decree gives effect to the principles of transparency, simplification and reasonable costs for customers provided for in the law; it also clears up some interpretative doubts to which market participants had drawn attention during the public consultation. The choices made go in the direction that I have indicated to be desirable, including in my Concluding Remarks in May: towards legislation based mainly on the promotion of competition, transparency and consumers’ awareness of their financial options. They meet BIS central bankers’ speeches the objective of allowing customers to understand the costs of the services provided, thus also helping to make competing offers comparable. Within the limits established by the law, their quantification will continue to be left to intermediaries. It is essential that charges be proportional to the costs banks bear in performing their activities and the risks they assume; in particular, the charges for making funds available must remunerate the services and risks connected with the liquidity guaranteed to the customer. The protection of consumers of banking and financial services is one of the Bank of Italy’s objectives; we pay it a high level of attention; we pursue it with a variety of instruments, including inspections at individual bank branches. Action to promote and develop citizens’ financial literacy increases their awareness when they face investment choices; we are taking a series of steps on this front too, aimed especially at the younger generations. Financial education is important, but it is even more important to seek the necessary complementarities with good regulation and supervision. Reduction of the risks for customers also depends on the reform of the rules governing non-bank intermediaries that grant credit, financial agents and loan brokers. In recent years the Bank has paid a high and increasing level of attention to such reform. The objective is to have rules that encourage a smaller number of sound and professional operators, together with reliable and diversified channels of distribution that can also stimulate competition in the sector. We have worked to permit the prompt application of the new rules. The usual cooperation was provided to the Ministry for the Economy and Finance for the drafting of the implementing measures within its sphere of competence; the framework for the supervisory rules to be applied to financial intermediaries is being prepared after a first round of public consultation; the necessary support has been provided for the start of operations of the Financial Agents and Loan Brokers Oversight Body, which a few days ago began to accept new registrations. In June the Council of Ministers approved the first reading of a measure that introduces further amendments to the text of the reform and is now being examined by Parliament. As regards the rules for financial agents and credit brokers, care must be taken to avoid uncertainty about the duties and powers of supervision and interpretative and applicative difficulties for the market. *** The Italian economy needs intermediaries and financial markets that allocate the savings entrusted to them in the best possible way and at the lowest possible cost. In this period banks are being called on to make difficult decisions: to ensure viable businesses continue to be financed and to avoid prolonging support for those destined to fail. This is the essence of sound and prudent management. The timing and strength of the economic recovery also depend on the outcome of these choices. In Italy the ratio of corporate debt to GDP is similar to the level in the other leading euro-area economies. Here bank loans to the productive sector are a larger share of the total, a difference that is only partly explained by the greater presence of small and medium-sized firms. For many businesses bank loans are the sole source of external funding, even though their size and characteristics are comparable to those of firms that in other countries raise funds directly on the capital markets. A very large portion of the risk stemming from business activities falls on banks’ balance sheets, and in times of recession translates into impaired loans, bad debts and losses, with serious repercussions on the flow of new lending. The costs are high for banks and for the economy. In the medium term there is a need to achieve greater access to the capital markets for Italian firms, through the adoption of consistent incentive policies. Starting now, banks must BIS central bankers’ speeches review the validity of their business models in relation to firms, especially large ones. Lending policies must be based on the solidity of business plans, not on relationships and connections that are irrelevant to them: forged in times of economic growth and easy funding conditions, they are no longer sustainable today. Banks that are attentive to firms’ growth prospects, and firms that in turn are more highly capitalized and more willing to access capital markets directly, are preconditions for ensuring that the Italian economy emerges from this crisis on a path to lasting recovery. BIS central bankers’ speeches | bank of italy | 2,012 | 7 |
Statement by Mr Ignazio Visco, Governor of the Bank of Italy, on behalf of the Constituency representing Albania, Greece, Italy, Malta, Portugal, San Marino and Timor-Leste, to the Development Committee, Tokyo, 13 October 2012. | Ignazio Visco: Creating job, eradicating poverty and achieving sustainable prosperity Statement by Mr Ignazio Visco, Governor of the Bank of Italy, on behalf of the Constituency representing Albania, Greece, Italy, Malta, Portugal, San Marino and Timor-Leste, to the Development Committee, Tokyo, 13 October 2012. * 1. * * Creating jobs for development: a challenge for all countries According to the ILO’s latest estimates for 2012, the global number of unemployed is 200 million, about 30 million more than in 2007. At the same time, the share of the working age population with a job declined to an estimated 60.3 per cent in 2012 from 61.2 per cent in 2007. This scenario is projected to remain mostly unchanged in the coming years and can even turn out to be optimistic should some of the downward risks materialize. Thus, the World Development Report (WDR) 2013 on jobs recently published and its companion paper “Creating jobs for development: policy directions from the 2013 World Development Report on Jobs” are timely in addressing one of the most pressing problems for many policy makers around the world. They also offer an opportunity to refocus the attention of the Bank on its original mandate of eradicating poverty and boosting prosperity. Jobs and especially good jobs, are the main avenue to achieve both goals. As the WDR 2013 states, it is for the private sector to create economically and socially sustainable jobs, and for the government to provide a stable macroeconomic environment, an investment friendly business climate, a solid rule of law and a balanced labor market regulation. Policies and interventions will need to be tailored to each country’s initial conditions, based on the diagnosis of the constraints to job creation. 2. The Knowledge Bank: implications for the business model The strategy that aims at eradicating absolute poverty in poor countries and achieving sustainable and inclusive prosperity in middle income countries deserves support. Financial resources need to be directed with priority towards countries that do not have access to the market at a reasonable cost. On the contrary, about 50 per cent of the overall IBRD exposure is currently to countries with per capita income above 2,900 US dollars, and 30 per cent is to countries that can borrow from the market at a spread of no more than 150 basis points over the corresponding US Treasury. Redirecting financial resources to the least developed countries cannot imply that the WBG ceases to serve Middle Income Countries. The WBG needs to define a new engagement strategy with MICs based on the second pillar of the mandate: boosting prosperity. Achieving this goal requires knowledge and practical solutions, which are somewhat scarce. The WBG should provide what these countries cannot find on the market. The Knowledge Bank should be an active knowledge manager able to mobilize its own expertise, know-how and information to provide tailored solutions to the specific problems of each single client. The development of a full scale business line of knowledge production and management is to be encouraged, provided that it is based on three principles: knowledge products need to be of the highest quality; they have to respond to countries’ needs and demands, rather than being supply driven; they need to be provided on a cost recovery basis and contribute to sustaining the income generating capacity of the WBG. This market test would ensure that the knowledge products have value added for the MICs. BIS central bankers’ speeches This strategy would free up enough IBRD lending capacity to meet the needs of the poorer members of the institution, without reducing revenues. However, the income generating capacity of WBG depends also on keeping costs under control. Increasing the efficiency of the World Bank through the current modernization process is of the upmost importance. In the medium term, it is necessary to reassess whether the current structure of WBG based on four organizations, IBRD, IDA, IFC, MIGA, is still the best suited to serve the clients of the 21st century, or whether it is a legacy of the past that needs to be reorganized in a more efficient fashion. While searching for an answer, one can achieve valuable efficiency gains and cost savings by merging across institutions back office functions such as treasury, controller, risk management, human resources, information technology, general services, external relations, and unifying the country offices. Making the most out of scarce resources by redesigning a very lean and efficient organization is a moral obligation to taxpayers and, more importantly, to the 1.3 billion of poor people around the globe. BIS central bankers’ speeches | bank of italy | 2,012 | 10 |
Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the 88th World Savings Day, organized by the Association of Italian Savings Banks (ACRI), Rome, 31 October 2012. | Ignazio Visco: 2012 World Savings Day Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the 88th World Savings Day, organized by the Association of Italian Savings Banks (ACRI), Rome, 31 October 2012. * 1. * * Savings and the financial system Savings constitute a fundamental raw material for the balanced development of a country, making it possible to finance investment without running an external deficit. Savings make households less vulnerable to cyclical downturns, so that they can look to the future with confidence. In Italy the saving rate – traditionally one of the industrial world’s highest – has been diminishing for over twenty years. Since the onset of the crisis the decline has sharpened. The share of national income saved is now below the European average: under 17 per cent, about 4 percentage points less than in the middle of the last decade, compared with 22 per cent in Germany and 18 per cent in France. The decline in the saving rate is due above all to decreasing saving on the part of households. Households can rely on bank loans more than in the past. At the end of 2011 outstanding consumer credit was equal to 11 per cent of households’ disposable income and mortgage loans to 32 per cent, about three times the values recorded in the late 1990s. A second major factor in the diminishing propensity to save is a fall in real household income of 9 per cent over the last five years, after rising modestly in the decade preceding the financial crisis. Italian households have buffered the impact on their consumption habits by drawing on their accumulated savings and reducing new saving. In France and Germany, by contrast, households’ disposable income and consumption have risen, if only slowly, over the entire period. Households are finding it harder to set aside the amount of resources they would like to in order to cope with the risks to jobs and future income. Istat’s surveys have found that since the first half of the last decade the share of households wanting to save has risen by 15 percentage points to 90 per cent, while the share of those able to do so has fallen by 10 points to 26 per cent. The gap is widest for the older and the younger households, and among the latter above all for the better educated, those with fixed-term jobs, and tenants. There is the risk of a vicious circle: economic growth is slow, saving capacity is reduced, households are more uncertain and discouraged, growth weakens further. In the past year the decline in household and business confidence has come on top of the direct effects of heightened sovereign risk and the consequent tensions in the credit market, the public finance adjustment measures and the slowdown in world demand. For the economy to return to its potential growth path, to the benefit of saving capacity, the gradual easing of these effects must continue and strengthen. The state of saving and its function within the economy also depend on the health of the financial system, which is central in putting its formation in relation with its utilization, in distributing funds from place to place and from today to tomorrow, ensuring that funds reach those who deserve them and removing liquidity constraints. The Italian financial system has not suffered from the hypertrophy, the periods of tumultuous expansion, that in other countries were conducive to improper behaviour and generated uncontrollable imbalances. In 2011 the assets held by financial institutions were worth 3.5 times GDP in Italy, 6 times GDP in the euro area as a whole, 14.5 times in the United Kingdom and 23 times in Ireland. Between 2001 and 2011, the nominal value of these assets increased by nearly 90 per cent in Italy, 110 per cent in the euro area, 160 per cent in the UK and 240 per cent in Ireland. The Italian financial system is far removed from the BIS central bankers’ speeches excesses that have marked other countries as regards the interconnection of financial institutions, a characteristic that may entail high risk. Episodes of improper conduct, however serious, have not dented the stability of the system. The Bank of Italy is intransigent with respect to mismanagement; it uses all the instruments at its disposal, including extraordinary measures, to avoid irregularities, to contain their repercussions on consumer confidence and the soundness of banks, and to favour the optimal allocation of savings. The reform of financial intermediation that was initiated in 2010 for non-bank institutions providing credit, financial agents and loan brokers is designed to favour the market presence of professional operators, reliable and diversified distribution channels and more effective supervision through specialized entities. The primary legislation in this field is now complete. The full rationalization of the sector and effective supervisory action now depend on the issue of the necessary ministerial measures. The financial system’s main counterparties – households and firms – are not suffering from serious imbalances in Italy. The net wealth of Italian consumer and producer households is high by international standards and is associated with low debt. The ratio of households’ financial debt to disposable income is 65 per cent in Italy, above 80 per cent in France and Germany, and nearly 100 per cent in the euro area. The vulnerability of the 2 per cent of Italian households that have to sustain debt service of more than 30 per cent of income depends strictly on cyclical developments and the state of the labour market, and it has been attenuated by programmes of support for households in difficulty, such as the debt moratorium agreed on by the Italian Banking Association and consumer organizations and recently extended to January 2013. The financial debt of Italian firms amounts to about 80 per cent of GDP, some 10 percentage points more than in Germany but over 20 points less than in France, almost 30 points less than in the UK and over 50 less than in Spain. However, corporate balance sheets are suffering from the impact of two recessions within the span of just four years and the consequent decline in profitability to a twenty-year low. Despite low interest rates, financial expense now absorbs over one fifth of internally-generated resources. In the course of the year some faint signs of improvement have emerged. The lengthening of payment terms between businesses has ceased, and large corporations have resumed issuing bonds. Financial analysts’ forecasts and the most recent business surveys point to an attenuation of the pessimism over the outlook for economic activity, especially exports. In very difficult times the Italian financial system has continued to function as a fundamental infrastructure for the economy. In the early part of the crisis the Italian system was less severely affected than those of other countries, having practically negligible recourse to government support, far less than other banking systems. The latest survey by the European Commission found that as of last June public capital injections into Italian banks amounted to 0.2 per cent of GDP, against 5.2 per cent in the Netherlands, 4.3 per cent in Belgium and 1.8 per cent in Germany. Here, in contrast with other countries, the banks suffered from, did not cause, the deterioration in the public finances. The sovereign debt crisis is still limiting their access to wholesale funding. The Bank of Italy’s controls and supervisory practices, banks’ low exposure to structured finance products, and the absence of a real estate bubble are what underlie the stability of the Italian banking system. These factors explain the lesser need for government intervention. However, the banks are suffering from the protracted economic recession. To preserve their ability to finance the economy, they must take full advantage of the scope for increasing efficiency. BIS central bankers’ speeches 2. Credit and the banking system The deleterious spiral linking the sovereign debt crisis, banks’ access to funds, credit availability and economic growth must be broken once and for all. The measures decided by the ECB Governing Council, together with those adopted by governments at national and European level, are already having positive effects. But we still have not reached a definite turning-point. The growth of bank lending remains negative. In the three months to September the annualized contraction in loans was 3.5 per cent for firms and 0.8 per cent for households. The weakness of demand has weighed increasingly on the recent trend in credit. Firms are cutting back on investment, given the unfavourable economic prospects, while households are cautious in the face of the uncertain trend in the housing market and the difficulties for income and employment. But supply-side conditions that are still restrictive, though an improvement on the exceptional tensions registered in late 2011 and early 2012, also continue to be factor. In the bank lending survey conducted at the start of October for the third quarter of this year, the banks relate the tightening of supply to the poor economic situation and the consequent increase in credit risk. The surveys of firms give mixed signals of the speed at which the credit tightening is unwinding. In the quarterly survey carried out by the Bank of Italy together with Il Sole 24 Ore, the percentage of firms indicating a deterioration in their conditions of access to credit declined to about 26 per cent in September, from 33 per cent in June; whereas the monthly Istat survey showed a new increase. The reduction in official rates in July has had positive effects on the cost of credit. Bank lending rates came down over the summer by 0.3 percentage points both on new loans to firms and on new mortgage loans to households, to 3.5 and 3.9 per cent respectively in September. A contributory factor was the narrowing of the yield spread between Italian and German government bonds following the announcement of new interventions by the ECB on the sovereign debt market. However, the cost of business loans is still higher than in Germany and in the euro area as a whole (by 1.1 and 0.8 percentage points respectively); before the summer of 2011 the differential was practically nil. The gap reflects the sovereign debt tensions and the consequent unevenness of monetary policy transmission in the diverse economies of the area. Other conditions being equal, an increase of 100 basis points in the yield spread between ten-year Italian and German government bonds tends to be reflected in an increase of about 50 basis points in the average rates on loans to firms in Italy after one quarter and fully after a year. In September, the banks’ total funding, excluding Eurosystem refinancing, was down by 2.6 per cent from twelve months earlier. The difficulty of raising funds, particularly acute between the summer of 2011 and last spring, has regarded foreign deposits – almost entirely interbank deposits – and bond issues on international wholesale markets. In recent months, however, we have begun to see signs of a recovery, including in the uncollateralized segment; total issues have amounted to €11 billion, of which €8 billion unsecured. In periods of strain the decline in fund-raising on the market has been offset by greater recourse to Eurosystem refinancing (which has increased by €250 billion since May 2011), thanks to which Italian banks can cover the wholesale bonds falling due in 2013–14. In more recent months, with the general improvement in market conditions, central bank lending to Italian banks has stabilized. Retail funding remains a strong point of Italian banks. Italian households’ deposits grew by 3.7 per cent in the twelve months to September, and substantial subscription of bank bonds by retail investors continued. Loan quality is worsening. In the second quarter of this year, the ratio of adjusted new bad debts to loans outstanding rose to 2.1 per cent, returning to around the end-2009 level. The BIS central bankers’ speeches deterioration involved loans to firms, the default rate on which reached 3.2 per cent, with a high of over 6 per cent for construction firms. Preliminary data indicate that the deterioration has not halted in the last few months. By contrast, the default rate on loans to households remained stable at 1.2 per cent, relatively low by the standards of the past. In June of this year gross impaired loans (bad debts, substandard and restructured loans and overdue positions), three quarters of which involved firms, amounted to 12.3 per cent of total bank lending; in 2007 the figure had been 5.1 per cent. Taking into account the write-downs already made, the ratio falls to 8.1 per cent. These numbers are still far below the peaks registered in the early 1990s, but they could cause concern if set against those of other advanced economies. But international comparisons are difficult. The accounting criteria used by banks in Italy to classify loans as impaired are dictated by particularly severe prudential rules. Added to this is strict prudential and on-site supervision by the Bank of Italy, which requires even more stringent assessments of loan quality. For example, on-site inspections in the first half of 2012 resulted in the reclassification of 20 per cent of the loans examined. Furthermore, the extreme length of credit recovery proceedings, due to the slowness of the justice system, obliges banks to keep impaired loans on their balance sheets longer than in other countries, which works to Italy’s disadvantage in international comparisons. Even if banks have increased their value adjustments, the ratio of these write-downs to the total amount of impaired exposures has fallen since 2007 from more than 49 per cent to just over 37 per cent. It is higher for banks belonging to the top five banking groups, lower for smaller banks. Focusing on bad debts alone, the coverage ratio is above 54 per cent; for those not backed by collateral or personal guarantees it is naturally higher, at 68 per cent. Coverage ratios need to be raised. The Bank of Italy regularly monitors their adequacy, bank by bank, in relation to the credit risks deriving from economic and financial market developments. We expect banks to devote the greatest care to taking this aspect into account in their balance sheets. Although the setting is unfavourable, the banks have strengthened their capital position very substantially. This action must continue, both in order to cope with the worsening of loan quality and to satisfy the new, higher capital ratios required by the Basel III rules. Supervision of capital adequacy is particularly stringent for banks whose impaired loan coverage ratios are low. Smaller loan volumes and larger value adjustments to loans have had repercussions on banks’ earnings. On an annualized basis and net of goodwill impairments, ROE fell to 3.2 per cent in the first half of this year, compared with 4.1 per cent in the first half of 2011. A recovery in profitability can support the necessary further improvement in banks’ capital position. It must come from an improvement in efficiency both in supplying products and in curbing costs. Encouraging signs can be glimpsed with regard to costs, which decreased by 1.2 per cent in the first half of this year compared with a year earlier; the decline was sharper for labour costs, which fell by 1.8 per cent. It is necessary to continue containing staff numbers and curbing personnel costs, not just for new employees as envisaged by the new national labour contract, but also managers’ and directors’ compensation. Dividend distribution must be weighed carefully, especially where there is a need to maintain or strengthen capital ratios. The rules on banks’ compensation systems are producing their effects. The aim is to relate the pay of top managers and directors to effective performance and make it reflect the risks assumed. In 2011 the compensation of top executives in the five largest banking groups decreased by an average of 25 per cent compared with the previous year; for the first fifteen listed groups, the decrease came to 20 per cent, net of severance packages. BIS central bankers’ speeches The Bank of Italy is subjecting banks where compensation has risen to special scrutiny, and inquiries are under way on the mechanisms for determining the variable pay components. In the event of the early conclusion of employment relationships, the rules lay down that a significant part of compensation must be deferred for a sufficient period of time or subject to claw- back clauses. These provisions must be such as to discourage mismanagement and to protect banks even after the termination of employment. Directors must guarantee their effectiveness. Banks must rationalize their distribution networks, by making more efficient use of information and communication technologies. The number of bank branches rose in the last decade, despite the sharp increase in the share of telephone and on-line banking services. An overlapping of distribution channels may be justified in part by differences in banks’ customer base and commercial strategies, but efficiency gains are certainly possible and necessary. Non-strategic assets need to be sold off. In the immediate, cost-cutting must be relied on in order to avoid severe imbalances in profit and loss accounts. Beyond the short term, however, this will not be sufficient. It is time now to realistically assess the opportunities for greater diversification of income, for a reorganization of business processes, especially in the granting of credit. Greater support must be given to creditworthy borrowers, accompanying them in strengthening their financial structure and expanding in international markets. 3. The stability of the euro area and the European banking union The crisis in the euro area reflects two risk factors: the weaknesses of several member states, which fuel doubts about the sustainability of their public debt, and the incompleteness of the European construction, which is the source of broader fears that the single currency may be reversible. To address the first risk, the authorities in the countries most exposed to the crisis have taken resolute action to adjust the public finances and mend structural shortcomings. In Italy the measures taken since the second half of 2011 to consolidate the public finances and the major package of structural reforms now being enacted have helped stanch the loss of confidence in our economy. The budget measures could not but have negative repercussions on short-term economic developments, but they averted far bleaker scenarios than the current one. In the medium term, the structural reforms will sustain the country’s growth potential. It is vital that the announced budget targets be met, the reform programme implemented in full and its scope widened even further. To definitively dispel fears about the solidity of monetary union, it is essential to proceed, with the necessary gradualness, from economic and monetary union towards political union, via reform of economic governance and banking and fiscal union. This is a project for the long term. The persistence of tensions in the sovereign debt markets during its implementation could compromise the uniformity of monetary policy transmission, as the experience of recent years has shown. To avert this risk, the Governing Council of the ECB approved Outright Monetary Transactions (OMTs). This has already had important effects, as is attested by the signs of renewed interest in Italian government bonds on the part of foreign investors and the consequent narrowing of the spread between BTPs and Bunds. Given that the fears of euro reversibility are bound up with those for the sustainability of the public finances of member countries, the start and continuation of OMTs is conditional on the assumption and respect of specific commitments regarding the public finances and structural reforms. As I noted, we are mindful that a definitive solution to the euro-area crisis requires the completion of the European construction. Much has been done with the reforms of economic governance aimed at strengthening budget coordination and extending BIS central bankers’ speeches multilateral oversight to macroeconomic imbalances. Banking union represents a further, important step in breaking the link between the conditions of sovereign states and those of banks and in consolidating the financial stability of the area. Banking union will mean a single mechanism for banking supervision and a European blueprint for the resolution of banking crises, in addition to a common deposit insurance scheme. The inception of the single supervisory system will help reassure the markets that the European institutions and member states are determined to strengthen monetary union. A few days ago, the European Council called on national legislators to give absolute priority to the talks under way so as to define the new legislative framework before 1 January 2013, to be implemented in the months that follow. Implementation must necessarily be gradual but there must be, from the very beginning, a clear vision of what the final mechanism will look like and a detailed calendar for the intermediate steps. This is a challenge that carries important institutional and operational implications. The responsibility for common supervision will be centralized at the Governing Council of the ECB, of which the national central bank governors are members. A special body for planning and carrying out supervision will be established at the ECB. National authorities will be required to be fully engaged, both in the day-to-day conduct of supervision and in decision-making. Given the large number of small banks operating in the area, it is unrealistic to imagine centralizing every task. The ultimate responsibility for all the banks in the euro area will lie with the ECB, but to a varying degree and with modalities differentiated according to the banks’ characteristics. It will have full and direct responsibility for decisions concerning systemically important banks and those that receive public support. For the other banks, supervision can be carried out more effectively by the national authorities. In any event, the ECB will take decisions on the banking sector as a whole, with reference for example to supervisory recommendations and guidelines, including stress testing. Uniform regulatory and supervisory standards will have to be guaranteed for all banks, in order to avoid segmentation and arbitrage and to preserve the integrity of the European banking market. It is vital to avoid any lowering of supervisory standards; on the contrary, we must seize the opportunity to ensure convergence towards the most rigorous practices among those adopted by the various national authorities. Supervisors will require a comprehensive and detailed dataset, as well as methodologies of risk analysis capable of providing timely indications of emerging instability at individual banks and at systemic level. The European blueprint for the resolution of banking crises must have shared financial resources. The authorities must have the power to order the conversion of debt instruments into equity or the reduction of a bank’s liabilities, imposing losses on some classes of creditor (through bail-ins). The proposed Bank Recovery and Resolution Directive is a step in this direction. ° ° ° The efforts being made in Europe and in the countries worst hit by the crisis can succeed only if all the parties involved keep full faith with their commitments. In the end, budgetary adjustments without structural reforms would inevitably be counterproductive. However, the reforms will be unable to work their effects in full if doubts and uncertainties about the future of the single currency were to keep sovereign spreads far above the levels consistent with each country’s economic fundamentals. Monetary policy can constitute an effective bulwark against such distortions. But its benefits can be lasting only if budgetary discipline and national and European reform proceed with the necessary determination. BIS central bankers’ speeches | bank of italy | 2,012 | 11 |
Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the ASSIOM FOREX (the Financial Markets Association of Italy), Bergamo, 9 February 2013. | Ignazio Visco: Effective reforms needed for balanced and rapid growth of the Italian economy Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the ASSIOM FOREX (the Financial Markets Association of Italy), Bergamo, 9 February 2013. * * * Italy has not yet left behind the effects of the financial crisis and the double-dip recession that accompanied it. The renewed decline in economic activity that began in mid-2011 has wiped out the partial recovery that took place after 2009: GDP has fallen to about 7 percentage points below its pre-crisis level; in five years industrial output and gross fixed investment have fallen by almost a quarter and the number of people in work by more than half a million. The decline in activity could come to a halt in the second half of 2013, with a return to modest growth rates and with a high margin of uncertainty. I am not going to talk about the forces which could spark the recovery, nor about the risks overshadowing this scenario. These topics are discussed in the Bank’s Economic Bulletin, published in January. It is crucial that the progress made in the sovereign debt market continue and increase. It followed on the ECB’s announcement of the new procedures for Outright Monetary Transactions (OMTs) in the secondary markets for government securities, accompanied and made possible by an overhaul of European economic governance, the agreements on assistance to Greece, and the preparation and implementation of public finance consolidation programmes and reforms in the countries affected by financial strains. While due attention should be paid to the need to mitigate their social and income-distribution effects, these programmes must continue. In Italy, this means an effort should be made to significantly improve firms’ competitiveness by containing costs but above all by increasing productivity, including a far-reaching modernization of industry and private services and larger and better productive investments and technological innovations, in a setting of simpler rules and more efficient public services. The issue of the high level of taxation for Italy’s citizens, firms and banks is also crucial. It must be tackled in a medium-term perspective, with a balanced and farsighted approach that takes account of budget constraints. The case of Monte dei Paschi di Siena and the control of financial risks In the past we have argued that our banking system has withstood the global financial crisis thanks to its fundamentally sound business model and limited exposure to structured financial products, within a regulatory and supervisory framework oriented to prudence. The exceptionally long and deep recession, however, has inevitably affected the quality of bank loans, while the deterioration in the creditworthiness of the sovereign issuer has increased the cost of funding and made it especially difficult for Italian banks to procure resources in the international market. The grave developments of recent weeks at Monte dei Paschi di Siena (MPS) do not alter our assessment of the overall state of the Italian banking system. The MPS group’s problems originated in an ambitious acquisition carried out on the eve of the crisis, by procedures which are now being subjected to intense and obligatory scrutiny, as well as in poor management of financial risks, whose repercussions were aggravated by the sovereign debt crisis. Even counting the additional interventions already decided for MPS, the public support provided to banks in Italy remains very limited by comparison with other countries. Public recapitalizations in Italy have amounted to 0.3 per cent of GDP. According to the latest study of the European Commission, as of June 2012 such aid came to 1.8 per cent of GDP in BIS central bankers’ speeches Germany, 2.0 per cent in Spain, 4.3 per cent in Belgium, 5.2 per cent in the Netherlands, and over 40 per cent in Ireland. For the Spanish banks, a programme of recapitalization using European funds of up to €100 billion was authorized in July, of which €41 billion (3.9 per cent of GDP) has already been disbursed. Unlike many of the foreign interventions, the support extended to MPS, like that given to other, smaller Italian banks in recent years, is not the bail-out of a troubled bank. It is in the form of a loan that is eligible as regulatory capital, granted by the government at an interest rate that is particularly high and rising over time. The intervention was decided last summer in order to enable MPS to comply with the European Banking Authority’s recommendation to constitute an exceptional and temporary capital buffer, well beyond the minimum capital requirement, against its large holdings of government securities. This support, provided by the government in complete compliance with the European rules on state aid, was authorized by the European Commission. The Bank of Italy’s assessment of the current and prospective capital adequacy of MPS, in the opinion submitted under the law to the Ministry for the Economy and Finance, is positive. In the course of the last two decades the balance sheets of the major banks around the world have grown more complex. Alongside the inherent difficulty of evaluating the quality of loans, there is the problem of fully understanding the effective role of the structured financial products that the banks hold for investment or hedging purposes. The importance of these products for Italian banks is limited, definitely less than for other important banking systems. Derivatives and structured finance products can facilitate risk management for well-informed operators. The granting of fixed-rate mortgages to households is favoured by the possibility of managing the related interest-rate risk; the internationalization of firms depends crucially on the possibility of hedging foreign exchange risk; and the provision of retirement saving products at low cost over very long time horizons benefits from the ability to mitigate the impact of fluctuations in securities prices. However, the high leverage and complexity typical of these instruments means that they can also be used to take high-risk, speculative positions; in addition, they can be used to mask the economic impact of previous transactions, exploiting the ample scope for interpretation allowed by accounting standards. Internationally, some banks have misused these instruments in recent years, in part in response to the drying-up of the sources of income from traditional credit business. These are the circumstances most likely to trigger fraudulent conduct designed to conceal from the market and from supervisors the real object of the derivative transactions. On the occasion of the recent parliamentary testimony of the Minister for the Economy and Finance, we furnished him with a detailed account of the case of MPS and our own supervisory actions. The document is available on our website. The rules, the procedures, the methods and the timing of our supervisory interventions are strictly and formally predetermined at every stage, in order to guarantee uniform application. They depend on the constraints of the law governing administrative procedures. The Bank of Italy is strongly committed to making its actions ever more effective and timely; we carefully consider all suggestions; we are open to a constructive dialogue. MPS resorted to complex financial transactions in part as a consequence of losses on previous financial investments. The transactions were presented, even to the Bank of Italy, as funding instruments and hedges against positions in government securities held as long-term investment. The correction of their accounting representation will produce a substantial negative effect on net worth as of the end of 2012. But the impact is not such as to compromise the bank’s overall capital adequacy. We took account of this in the opinion submitted to the Ministry for the Economy and Finance. These transactions gave rise to serious liquidity risks for MPS. We identified these risks in the course of 2010 and imposed a significant capital increase and a strengthening of the internal control and risk management system. We subsequently intensified our control BIS central bankers’ speeches activity, up to the decisive inspection begun in September 2011 and the consequent request in November of that year for a sharp change in the bank’s management. Our intervention has made it possible, in an environment of increasingly severe financial tensions, to preserve the bank’s stability by strengthening its capital base and beginning to bring the precarious liquidity situation back to normal. The transactions deemed to be illegitimate have been brought to the attention of the competent judicial authorities, with which the Bank of Italy’s Supervision Area and the Financial Intelligence Unit, for the matters within their respective powers, are cooperating fully. With the crisis, the need for strict regulation of the derivatives market has come to the fore. The initiatives promoted by the Financial Stability Board at the behest of the G-20 go in the right direction, increasing the market’s transparency through contract standardization, the requirement to trade on regulated markets, settlement through central counterparties, and the reporting of the terms and conditions of transactions to trade repositories. The aim is ambitious. Progress has been made, but it is necessary to pick up the pace, overcoming the difficulties of implementation, particularly for cross-border transactions, and the industry’s resistance. A timely reflection is under way at international level on the organizational structure of banks, on the need to separate traditional credit business from activity in the financial field. The reports of the Vickers Commission in the United Kingdom and the Liikanen Group for the European Commission trace out possible lines of intervention. With stringent rules for supervised institutions, it will be necessary to keep risks from migrating to the shadow banking system – the ensemble of intermediaries, products and markets that slip through the regulatory net. Let us not forget that the financial crisis originated in the US securitization market, largely populated by unregulated or scantily regulated operators. But the correct conduct of credit and financial business requires competence and good faith on the part of intermediaries, both factors being decisive to ensure sound and prudent management and preserve the confidence of savers. This necessity is heightened by the complexity of the external environment, by the presence of large intermediaries, and by the economic and reputational damage that can result from illicit behaviour. No market can function without rules, nor is prudent management possible without correct conduct, embodied not only in scrupulous compliance with the law and the supervisory rules but also in complete adherence to business ethics. In its supervisory action, the Bank of Italy has for some time intensified its discussions with banks’ directors and senior managers, reminding them of their responsibilities. We have imposed rules to ensure that boards are functional and suitably composed and that appointment procedures are transparent. However, the integrity and experience requirements are laid down by rigid legislative provisions: disqualification can be imposed only for failure to satisfy expressly listed criteria; when a bank is not in a crisis situation, the Bank of Italy may ask the shareholders to renew the governing bodies, but it cannot dictate their decisions, nor can it directly remove a member of the board. The legislative framework needs to be strengthened. The supervisory authority must be able to make a thorough assessment of the fitness of directors and senior managers, in accordance with standards of transparent and impartial administrative action. It must be able to intervene effectively in cases where, on the basis of solid evidence, it considers that it must object to the appointment of directors and senior managers or remove them from office. Good finance contributes to the working of the economy, to efficient allocation of risk, to removing liquidity constraints that can impede innovation and growth. Opportunistic behaviour must not be allowed to make finance an object of distrust. The role played by a robust and rigorous system of internal controls in banks is essential to avoid excessive risk-taking, especially when a bank operates in highly complex and innovative business segments. BIS central bankers’ speeches In the case of improper conduct, the truth must be sought unstintingly. Reports and suppositions must be checked scrupulously; if they are not properly verified, hypotheses and opinions which may be unfounded and rash can cause severe harm to savers, institutions and society as a whole. Saving is protected by the Constitution, Italian law and European legislation. We are well aware of this and act with all our powers in support of that protection. Italian banks There are other, more general problems of concern to public opinion or recurrent in discussions with economic operators and international organizations. A first important question is why credit to the economy has continued to contract, in Italy as in other euro-area countries, notwithstanding the exceptional measures adopted by the Governing Council of the ECB to support bank liquidity. Other questions centre on the quality of loans, the reliability of international comparisons and the credit assessments we require banks to make, at times considered overly stringent and such as to curb the financing of the economy. Another important issue is the profitability of banks, in light of the current economic and financial situation. Liquidity and credit to the economy The measures adopted by the ECB from late 2011 onwards – the two three-year refinancing operations (LTROs), the expansion of the range of assets eligible as collateral for refinancing with the central bank and, most recently, the announcement of Outright Monetary Transactions (OMTs) – kept the banks’ fund-raising difficulties in the markets from triggering a disorderly contraction of balance sheets and jeopardizing the functioning of the monetary policy transmission mechanism in the euro area. For Italian banks, whose ratio of lending to the more stable forms of funding approaches 120 per cent, these measures provided the means to cope with the decline in international interbank funding that began in mid-2011 and to redeem their maturing bonds. In 2012 residents’ deposits and bank bonds held by households expanded by €58 billion. Wholesale funding, instead, recorded a further contraction, equal to €76 billion, offset in part by net recourse to Eurosystem refinancing of €66 billion. In recent months the improvement in market conditions following the announcement of OMTs enabled the major Italian banks to resume bond issues, including of unsecured bonds. The amount of wholesale bonds maturing by the end of 2014, when the three-year LTROs expire, exceeds €110 billion. In part to address the need to constitute a liquidity reserve, in the course of 2012 banks increased their holdings of government securities by around €100 billion (of which one third with residual maturity of less than one year). Bank lending to the non-financial private sector diminished by €38 billion overall in 2012. The contraction was chiefly in loans to firms. Lending activity has been conditioned by the recession. If, on one level, the decline in output and investment was reflected in a fall in demand, on another the high volume of non-performing loans increased the risks for intermediaries. Without the longer-term refinancing measures decided by the ECB, the contraction in credit would have been devastating. The results of the quarterly Bank Lending Survey, also confirmed by surveys of firms, indicate that with respect to the extraordinary tightening recorded at the end of 2011 the terms of lending have improved significantly, but have still not normalized. Supply continues to be braked by high credit risk, above all in relation to the weakening of firms’ balance sheets. Partly for this reason, although the cost of credit for firms and households has declined from the levels reached at the end of 2011, it remains higher than the euro-area average; another factor is the persistent gap in the cost of funding. From the onset of the crisis a series of important measures were taken to support credit to firms, especially smaller ones. The Central Guarantee Fund for SMEs, which was increased BIS central bankers’ speeches during the crisis, was guaranteeing almost €14 billion in loans at the end of 2012. The two moratoria agreed by the Government, the Italian Banking Association, and employers’ associations involved the suspension of repayments amounting to almost €17 billion. Cassa Depositi e Prestiti made €18 billion available to banks for lending to SMEs. The resources involved are considerable. These measures have enabled a large number of firms to access credit. Any future reinforcement must aim to support the most dynamic and innovative firms, those best placed to contribute to the economic recovery. Credit quality, supervision and capital A growing number of firms are having difficulty repaying their loans: in the third quarter of 2012 the ratio of new bad debts to the stock of outstanding loans was 2.2 per cent for bank customers as a whole, while for firms it was 3.3 per cent. In November the share of loans to firms in temporary difficulty (substandard and restructured loans) again increased. By contrast, the deterioration in loans to households has been small, thanks to the limited amount of household debt and the low level of short-term interest rates. Statistics examined at international level suggesting that the ratio of impaired loans to total assets is higher for Italian banks than for those of the other leading countries have raised questions about the adequacy of the amounts in banks’ balance sheets to cover these risks. International comparisons of credit quality and the adequacy of write-downs nevertheless suffer from the lack of a uniform definition of impaired loans. For Italian banks the definition of impaired loans in conformity with rigorous prudential rules is broad. It includes assets, such as restructured loans, that continue to generate cash flows. Moreover, the incorporation of the reclassifications requested during the inspections that the Bank of Italy carries out periodically results in the prompt emergence of impaired loans, and the stock of them is kept large by the slowness of recovery procedures. It should also be noted that in the last few years the proportion of impaired loans backed by guarantees has risen for Italian banks. In the meetings with the International Monetary Fund, which is currently performing its periodic assessment of the stability of the Italian financial system, we stressed the need to bear these aspects in mind when attempting to draw policy implications from international comparisons. Another question that is sometimes raised is whether the loan assessments that we require banks to make are not excessively cautious and therefore likely to slow the financing of the economy. Here again it is necessary to be clear. The prudence we require in the assessment of loans helps to safeguard the integrity of banks’ capital and contributes to increasing the market’s confidence in them. Analysts and investors want the amounts stated in balance sheets to reflect the actual quality of banks’ assets and provide reliable indications of the risks involved. Prudent provisioning policies encourage the disposal of impaired items. It also needs to be recognized that such policies are likely to be hindered by a harsh tax treatment, which should be gradually removed. In periods of market tension, the intensity of supervision cannot be relaxed until the economic recovery produces its effects on banks’ accounts. Tolerance towards situations of persistent support to borrowers with a precarious financial condition and no prospect of growth would not only risk undermining the soundness of the banks but also hinder the efficient allocation of resources to the economy. The inspections we perform make it possible to assess the situation of each intermediary on a case-by-case basis. We pay due attention to the risk of generating procyclical effects. To this end, above all we ask banks that need to strengthen their capital bases to free resources by reducing their costs, selling non-strategic assets and retaining earnings in the business. Beyond the short term the prudent assessment of assets is beneficial to the financing of customers, especially if coupled with action by the banks to increase their ability to resist and BIS central bankers’ speeches react to external shocks. Efficient production processes and attention to strategic sectors contribute to the growth of credit business and in this way to the support of the economy. In recent years Italian banks have increased their capital resources considerably, especially core tier 1 capital. Since 2007 the core tier 1 ratio of the banking system has risen from 7.1 to 10.4 per cent. For the five largest banking groups, which have raised €17 billion on the equity market since 2011, the average core tier 1 capital ratio has risen from 5.7 to 10.8 per cent; the ratio stands at 8.8 per cent for the other banking groups and at 13.8 per cent for the smaller banks, mostly mutual banks. The capital of the smaller banks is generally adequate. Some large and medium-sized groups must make further progress in strengthening their own funds. Capital strengthening will permit compliance with the Basel 3 rules and achievement of the objectives that will be set for the assessment of banks’ overall risk profiles. It makes it possible to limit the degree of leverage without reducing credit support to the real economy. Capital strengthening is in the interest of shareholders: the resulting decrease in risk lays the foundation for reducing the cost of capital and, looking ahead, raises the return on the resources invested. A low exposure to financial risks also helps to curb the cost of funding. In 2012 the capital gains on government securities purchased at prices far below those consistent with the fundamentals of the Italian economy cushioned the impact of the macroeconomic deterioration on banks’ income statements. Any dividends paid must not draw on banks’ capital reserves; they must be compatible with capital targets communicated to banks at the end of the annual supervisory and review process. Banks’ profitability Given the persistently unfavourable economic and financial situation, it has been contended that banks’ profits are high, especially compared with those of firms. So the banks, the argument runs, should be called on to expand the supply and lower the cost of credit, to reduce their fees, and to offer an array of services free of charge. Actually, two recessions in the span of three years, undermining the quality of banks’ assets, have generated loan losses that seriously erode profitability. The sovereign debt crisis has made funding in the wholesale markets harder and more costly, further reducing the profitability of traditional credit activity. The profitability of the major banking groups is low. In the first nine months of 2012 their return on equity, annualized and net of extraordinary goodwill impairments, was just above 3 per cent. The modest growth in the volume of business and the incidence of loan losses will continue to compress banks’ earnings until the economic recovery takes hold. The uncertainty over economic and financial market developments will continue to weigh on the speed and the extent of the rebuilding of profit margins, which are in any event bound to remain below their unsustainable pre-crisis levels. The entrepreneurial nature of banks has been axiomatic for many years now, and capital cannot be raised in the absence of expectations of sustainable rates of return; the drive for profit is legitimate, it serves growth. However, earnings must derive not only from operating efficiency but also from offering products that correspond to customers’ real needs, not costly, needlessly complicated and risky services. In the first nine months of 2012 banks’ staff costs diminished by about 2.5 per cent compared with the year-earlier period. The containment of operating expenses must proceed resolutely. The banks must enhance the quality of human capital, which is essential to the assessment of creditworthiness and risk management. The variable portion of the compensation of risk takers must be reduced in line with banks’ earnings. Specifically, loss-making banks must not pay bonuses. Bonuses must reward the achievement of stable earnings, not simply the fruit of extraordinary operations. Only the BIS central bankers’ speeches structural components of income can serve as the standard for the determination of bonuses and, in the arrangements that so provide, for their restitution. Executives’ severance packages too must be clearly and effectively bound to the results attained. They must reflect proper evaluation of the manager’s performance. And compensation must be deferred long enough to validate the true quality of management. If banks do not conform spontaneously to these principles, rules and controls will have to be made more stringent. The spread of information and communication technology has affected the behaviour of customers, heightened competition and opened up new opportunities to streamline and digitize business processes. These trends require a revision of distribution channels that will be all the more important going forward. Maintaining a local presence is essential, but it has to be combined with the rationalization and upgrading of the branch network. The simplification of company and group structures remains a priority. In the problematic context in which these actions must be undertaken, the materialization of the savings expected requires significant improvement in the ability to actually carry them out. Concretely feasible solutions have to be designed long enough in advance, just as the investments necessary for their implementation need to be programmed. *** These are still difficult times for the Italian economy. The long financial crisis has taken a heavy toll on the markets and the institutions. It has put monetary union itself to a severe test. The banks are suffering the heavy consequences of the double-dip recession and the sovereign debt crisis. They have met with serious funding difficulties, coped with the need for capital strengthening, and suffered a sharp drop in profitability. Their initial, underlying soundness, also a reflection of supervisory action, has enabled them to withstand the shock. However, overcoming the crisis once and for all will necessitate a further, protracted effort. I have described the steps that are ineluctable, on which intermediaries must take action without delay. In addition, with the farsightedness demanded of all parties, the problem of the quality of ownership structure and governance must be addressed, bearing in mind the interest of the real economy and the stability of the banks themselves. The decisions of the ECB Governing Council, aimed at safeguarding the effective transmission of monetary policy within the euro area, have preserved the liquidity of the banking system, contained the financial market distortions caused by the sovereign debt crisis, and countered fears for the solidity of monetary union. We evaluate the correspondence between monetary conditions and economic outlook with the greatest care. Monetary policy can do much, but by itself it cannot get us out of the crisis. Investors’ fears have abated since the tension was at its height, but they have certainly not vanished. The quality of national economic policies and the completion of the reform of European economic governance moving towards full monetary, banking and fiscal union and, further down the road, political union as well will be decisive. Italy must not lower its guard. The international investors continue, rightly, to concentrate their attention on our ability to keep the public finances in balance and energetically pursue the goal of increasing potential growth. The recurrent tensions are a reminder of how fragile the situation remains. The yield spread between Italian and German government securities is still wider than is consistent with the fundamentals and potential of our economy. Its further reduction could facilitate banks’ funding and the revival of lending to the economy on more advantageous terms. The return to balanced and rapid growth of our economy must be pursued even more resolutely. Keeping the public finances in balance is a prerequisite to this, not an BIS central bankers’ speeches impediment. Only the full implementation of comprehensive and systematic reform, certainly a challenging task, can ensure the necessary gains in competitiveness and thereby favour the expansion of employment. The cornerstones of the reform have been identified: we must invest in knowledge, provide higher-quality public and private services, fight illegality and promote competition. We have barely embarked on this course; we must continue with conviction, aware of the responsibilities of each but confident in the possibilities of all. BIS central bankers’ speeches | bank of italy | 2,013 | 2 |
Lecture by Mr Ignazio Visco, Governor of the Bank of Italy, at the Imperial Business Insights, Imperial College, London, 5 March 2013. | Ignazio Visco: The financial sector after the crisis Lecture by Mr Ignazio Visco, Governor of the Bank of Italy, at the Imperial Business Insights, Imperial College, London, 5 March 2013. * * * I wish to thank for useful discussions and help Fabrizio Balassone, Paolo Del Giovane, Alessio De Vincenzo and Giuseppe Grande. Introduction1 The financial crisis has brought to the fore a number of problems. It has been severe and widespread, and has affected different economies in different and long-lasting ways. Financial stability has once again become a fundamental objective of policy making, and central banks are being heavily involved in this endeavour. This calls for a substantial overhaul in financial regulation and supervision, and the financial system of tomorrow will most likely be rather different from the one that has developed over the last two decades. Scepticism has grown about the role of finance in the economic system, and especially its apparent separation from, if not conflict with, the real economy. We should take stock of what has gone wrong, and in so doing reflect on the way forward, as it is already taking shape, as well as, perhaps, on how to better link our theories to real world developments. In the decade before the financial crisis both the size of the financial system and its role and pervasiveness in the economy increased dramatically. The process has only slowed down with the crisis. In the euro area, the overall amount of financial resources collected by the private sector (bank credit, bonds issued domestically and stock market capitalization) rose from 160 per cent of GDP in 1996 to 240 in 2007, and then declined to 230 in 2011. A similar pattern is found for the United States, where the ratio rose from 230 per cent in 1996 to 330 in 2007 and then declined to 260 in 2011, and for the UK, where the ratio increased from 240 to 330 per cent and then edged down to 320 per cent. The total outstanding notional amount of over-the-counter (OTC) and exchange-traded derivatives has risen from about 94 trillion U.S. dollars at the end of 1998 to around 486 trillion at the end of 2006, to reach 700 trillion in June 2012. Financial deepening, by allowing greater diversification of risk and making finance accessible to larger numbers of countries and firms, can be instrumental to broadening economic development. But there is a risk that finance turns into an end in itself, with consequences that can be more damaging as the system becomes more interconnected and the potential for externalities increases. The correct conduct of credit and financial business requires competence and good faith on the part of intermediaries as well as appropriate regulatory and supervisory regimes. “Good” finance as a force for good Finance has long been viewed as a morally dubious activity. My appeal to authority on this matter is a reference to a lecture delivered by Amartya Sen more than twenty years ago as the first Paolo Baffi Lecture on Money and Finance at the Banca d’Italia. Sen wondered: “How is it possible that an activity that is so useful has been viewed as being morally so This text, which has also been used for a lecture in Italian at the Accademia dei Lincei, in Rome, on 8 March 2013, partly draws on “What does society expect from the financial sector?”, panel discussion remarks following the Per Jacobsson Lecture by Dr. Y. V. Reddy, in Basel, on 24 June 2012, and on “The financial crisis and economists’ forecasts”, lecture at "La Sapienza" University, Rome, on 4 March 2009 (downloadable, respectively, from http://www.bis.org/events/agm2012/sp120624_visco.htm and http://www.bis.org /review/r090423f.pdf?frames=0). BIS central bankers’ speeches dubious?”.2 He recalled a series of historical episodes: Jesus driving the money lenders out of the temple, Solon cancelling debts and prohibiting many types of lending in ancient Greece, Aristotle describing interest as an unnatural and unjustified breeding of money from money. Superimposed on this “structural” mistrust, one can detect cyclical patterns in the public’s attitude towards finance, affected by the conditions of financial systems and shifts in the political mood about state intervention in the economy. Until the 1970s it was taken for granted that market failures required the presence and response of a regulator to avoid suboptimal results. Then came the great inflation of the 1970s, combined with high unemployment, and the emphasis shifted to government failures. Governments, central banks and other regulators were blamed for failing to prevent these developments. This eventually led to an ideological swing: a push to reduce the extent of state intervention. The failures of the “regulated economy,” the pace of technological advance and the rapid expansion of international trade after the end of the Cold War fuelled a protracted process of financial deregulation that was halted only by the financial crisis that broke out in 2007. The latter triggered a move toward re-regulation – or better regulation – that is still under way. The pendulum keeps swinging and will certainly continue to do so. The global financial crisis, with its huge costs for the whole society, has caused a further deep erosion of the trust in financial institutions. Witness to this are the widespread protests against the financial industry, from the Occupy Wall Street movement to the “Indignados” in Spain and their counterparts in other European countries. Anger has been fuelled not only by the discovery of wrongdoings and perverse incentives, but also by a perceived lack of action against those responsible, in a context of exceptionally high remunerations. The integrity of financial intermediaries’ codes of conduct has been called into question under many dimensions: honesty, the ability to manage financial risks and the commitment to take care of the interests of their clients. In the first place, public attention was caught by cases of investment fraud, in which Ponzi schemes or other types of malpractice and malfeasance led many people to lose their savings. Feelings were exacerbated by the generous severance packages paid to top managers after distressed financial institutions were rescued with taxpayer money. Dubious practices were found in key junctures of the financial systems, such as credit ratings and interbank reference rates, not to mention the allegations of financial institutions’ involvement in activities related to money laundering and other fraudulent practices. Most importantly, the crisis has shown that market participants were not capable of mastering the inherent complexity of the system that they themselves had contributed to develop over the course of the last two decades. Favoured by the breakthroughs in information technology and telecommunications, the securitization of banks’ assets expanded considerably, together with the supply of so-called structured financial instruments (ABSs, CDOs, etc.). The traditional model of credit intermediation gave way, especially but not only in the United States, to a system in which loans granted were rapidly transformed into other financial products having these loans as collateral and sold on the market: the socalled originate-to-distribute model (OTD). To the inherent difficulty of evaluating the quality of loans, these developments added the problem of fully understanding the effective role of structured financial products. Structured finance products and the OTD intermediation model can facilitate risk management. The granting of mortgages to households is favoured by the possibility of managing the related interest-rate risk; the internationalization of firms depends crucially on the possibility of hedging foreign exchange risk; and the provision of retirement saving A. Sen, Money and value: on the ethics and economics of finance, Paolo Baffi Lecture on Money and Finance, Rome, Bank of Italy, 1991, p. 28. BIS central bankers’ speeches products at low cost over very long time horizons benefits from the ability to mitigate the impact of fluctuations in security prices. With the OTD model, credit risk is not concentrated in the banks’ books, but is potentially dispersed among a multitude of investors. By making bank loans tradable, it reduces their illiquidity premium thus decreasing their cost. However, we now understand that structured finance and OTD intermediation, coupled with lack of transparency, favoured excess risk taking and opportunistic behaviour. Transactions often took place through scarcely regulated financial intermediaries characterized by high leverage and risk exposure, in particular as regards their valuation (in which a crucial role was played by rating agencies, without any particular control by regulatory authorities or information providers), by means of statistical models and often carried out on the basis of incomplete and insufficient data. In many instances complexity was instrumental to opportunistic behaviour fuelled by a distorted system of incentives especially with reference to executive compensation. The high leverage and complexity typical of structured financial instruments allowed them to be used to take high-risk, speculative positions. Unnecessarily complex and opaque assets were used to prevent a correct assessment of creditworthiness or mask the economic impact of previous transactions, exploiting the ample scope for interpretation allowed by accounting standards. Banks’ misuse of these instruments may also be linked to the drying-up of the sources of income from traditional credit business. This may have triggered actions designed to conceal from the market and from supervisors the real object of derivatives transactions. The bottom line is that financial innovation can allow more efficient allocation of credit risk, but it also entails a number of dangers, some of them intrinsic to its mechanism, others more generally related to the greater interdependence of the financial system. The ongoing process of financial consolidation and the OTD model have produced intermediaries that are closely intertwined with the capital markets. This has had some important consequences for financial stability: a more connected world improves risk diversification and can make markets more resilient, but when contagion is actually set off, an interlinked financial system heightens the risk that it may spread more widely. But the negative perception of banking and finance should not lead to a blind backlash. As Amartya Sen argued, “finance plays an important part in the prosperity and well-being of nations”.3 It is crucial for sharing and allocating risk, especially for poorer societies and people, insofar as risk aversion decreases with wealth. It is crucial for transferring resources over time and removing the liquidity constraints that hamper the economy and the exploitation of ideas. It is very important in promoting economic growth, especially by fostering innovation. Indeed, we have countless historical examples of good financial innovations. Think, for example, of the “letters of exchange” introduced by Italian merchants in the Middle Ages: they were probably the first fiduciary money, and trade benefited enormously from this financial instrument. More recently, consider the development of “micro-finance” in the 1970s: an innovation that has enhanced financial inclusion, helping poor borrowers to smooth their income and cope with illness or other temporary shocks. And, in the last two decades, recall the role of the “venture capital” industry in the promotion of successful innovative corporations such as Apple, Intel and Google. Some countries are now increasingly investing in efforts to improve the financial literacy of the public, and this too is important. On the one hand, it helps to build the demand side of a more inclusive finance. On the other, financially literate citizens are better able to understand the efforts of regulators and policy makers to improve supervision and regulation, and less likely to subscribe to the simplistic view that “finance is evil”. But we should realise that – as A. Sen, ibidem, p. 28. BIS central bankers’ speeches the case of Bernard Madoff and others in the US and elsewhere clearly show – this is no panacea (Madoff’s customers were surely much better educated than average). Therefore, for purposes of consumer protection in the financial services industry, financial regulation and good supervision are the necessary complements to financial education and inclusion. Complexity was also used, somewhat perversely, as an argument in favour of a sort of benign neglect on the part of regulators. The big financial players argued successfully that financial innovation was too complex and too opaque for the regulators to get their heads around. Indeed, they said, to safeguard the international financial system from systemic risk, the main priority was promoting an “industry-led” effort to improve internal risk management and related systems. This, in a nutshell, was the view espoused by the Group of Thirty report following the outbreak of the Asian crisis.4 But this thesis was often accompanied by the argument to the effect that “you, regulators and supervisors, will always be behind financial innovation; it would be better to allow us, the big financial international players, to selfregulate; we are grown-ups, we can take care of ourselves”. And, after all, “if someone makes mistakes some will gain what others lose; why can’t we be left alone to play this zerosum game of ours?” The regulators did not, in fact, have either the ability, or the right incentives to acquire the necessary information, for two reasons. First, the big financial players are global, and national regulators had powers too narrow to be able to confront them. The difficulties in coordinating the regulators’ actions, in the face of a natural tendency to preserve each one’s particular sphere of influence, was a powerful drag on the ability to rise to the challenge posed by a finance gone global. Second, the phenomenon of regulatory capture was a definite reality. Powerful political and economic influences were at play, and in some cases prevailed. Accepting the idea that benign neglect was the right course of action was, however, a critical mistake. The global financial crisis has highlighted the limits of the idea that self-regulation and market discipline are sufficient to ensure stable financial systems. Financial regulation and supervision have to keep pace with developments in the financial industry. National authorities need to be aware of the risk that their powers become narrow compared to the sphere of influence of the global financial players; the coordination of financial supervision across borders and across sectors is a key condition for the stability of the global financial system. More importantly, regulators and supervisors have to pay attention to keeping financial industry lobbies at due distance. All this calls for a major effort, at a national but especially at an international level, to adjust and strengthen the regulatory and supervisory financial framework. And it explains why the work that is carried out at various levels of relevance and responsibility in international fora is so important. In what follows I will review and assess recent reforms in financial regulation, highlighting those improvements that still need to be achieved. I will also discuss the importance of advances in our analytical understanding of the workings of financial markets and of its deviations from stationarity. In search of a better regulatory and supervisory regime Over the last few years the crisis has heightened appreciation of the benefits of a more stringent regulatory regime. At an international level, under the political impulse of the G-20, the Financial Stability Board (FSB) and the Basel Committee on Banking Supervision (BCBS) have introduced substantial regulatory changes to reduce the frequency of financial crises and increase the resilience of economic systems. Much has been already achieved. Group of Thirty, Global institutions, national supervision and systemic risk, 1997. See also the article by J. Heimann, with the same title, and comments therein, in the special issue of Banca Nazionale del Lavoro Quarterly Review on “Globalization and stable financial markets”, March 1998. BIS central bankers’ speeches The quantity and quality of capital that banks need to hold has been significantly enhanced to ensure that they operate on a safe and sound basis. Minimum capital requirements have been raised. The improvement in the quality of capital aims to ensure that banks are better able to absorb losses on both a going concern and a gone concern basis. The risk coverage has been increased, in particular for trading activities, securitisations and exposures related to off-balance sheet vehicles and arising from derivatives. An internationally harmonised maximum leverage ratio is going to be introduced, to serve as a backstop to the risk-based capital measure and to contain the build-up of excessive leverage in the system. The BCBS has also introduced international standards for bank liquidity and funding, designed to promote the resilience of banks to liquidity shocks. A milestone agreement was recently reached among Central Bank Governors and Heads of Supervision to adopt a minimum requirement for the ratio between high quality liquid assets and net liquidity outflows that banks would face over a one-month horizon in stress conditions (Liquidity Coverage Ratio – LCR). The minimum LCR will increase gradually in the coming years, so as to ensure that the new liquidity standard will not hinder the ability of the global banking system to finance recovery. And countries with distressed banking systems will have flexibility in its application. At the behest of the G-20, the FSB has promoted initiatives to strengthen the regulation of the OTC derivatives market. The aim is to reinforce market infrastructures, in order to minimise contagion and spill-over effects among players that have become more and more interconnected. These initiatives increase market transparency through a number of measures: contract standardization, the requirement to trade on regulated markets, settlement through central counterparties, the reporting of the terms and conditions of transactions to trade repositories. But further progress is needed in important areas. Capital and liquidity regulation must be accompanied by improvements in internal risk control arrangements and by actions aimed at correcting incentives to excessive risk-taking. Board members and senior managers should possess a thorough understanding of the bank’s overall operational structure and risks. It is also fundamental that supervisors regularly assess banks’ corporate governance policies and practices. Compensation policies also need to be revised, in order to better align remuneration with risk-adjusted long-term performance and avoid excessive risk-taking and short-termism. In particular, when designing compensation policies, banks should take into account a number of issues: the variable portion of the compensation of risk takers must be paid on the basis of individual, business-unit and firm-wide measures that adequately assess risk-adjusted performance; bonuses must reward the achievement of stable earnings, not simply the fruit of extraordinary operations; executives’ severance packages too must be clearly and effectively bound to the results attained, and reflect a more general evaluation of the manager’s performance; compensation must be deferred long enough to validate the true quality of management. The debate that has started with the so-called Volcker rule on the organizational structure of banks and the need to separate traditional credit business from activity in the financial field has been recently reinvigorated at a European level by the reports of the Vickers Commission in the United Kingdom and the Liikanen Group for the European Commission. Both the Volcker rule and the reports call for a much needed discussion around business size and complexity in the financial sector; the experience of the crisis has indeed shown that we should not be shy to thoroughly re-assess relative merits and costs of both (size and complexity). These reports trace out possible lines of intervention. Protecting retail deposits and taxpayers’ money from the risks implicit in trading activities (what used to be called “speculation”) – the rationale behind these proposals – is crucial. The experience of the crisis has shown that, even if no specific business model has performed particularly well or poorly, the banks’ organizational structure has an impact on the propensity of managers to engage in excessively risky activities. We should recognize that both retail and investment banking, BIS central bankers’ speeches even if organizationally or institutionally separate, should be properly regulated, and should be careful not to have a too ample definition of market making activity. At all events, in today’s globalized world it is crucial to make sure that countries cooperate and agree on the appropriate stringency of financial regulation. Countries should not compete by relaxing rules in order to attract financial intermediaries, as this generates negative externalities for other countries. This is a most delicate issue, and while a perfectly level playing field may not be achievable, we have to be conscious of the consequences of a “beggar-thy-neighbour” approach to regulation. The transition to a uniform system of rules and oversight of the financial sector must be hastened. In the euro area, and in the European Union at large, the plan for a banking union is ambitious, but it goes in the right direction. Some progress has been made on the convergence towards a single set of global accounting standards; but much remains to be done. The International Accounting Standards Board and the US Financial Accounting Standards Board expect to make progress on the two key outstanding issues of impairment of loans, where their deliberations should be completed by the end of the year, and insurance contracts, where both Boards will be holding public consultations this year. Of these two outstanding issues, the need for convergence on a new forward-looking expected loss approach to provisioning is of most immediate concern for end-users and from a financial stability perspective. One element that is essential for guaranteeing systemic stability is the method of measuring risk-weighted assets (RWA), the denominator of capital adequacy ratios. RWA measures have recently attracted increasing attention from market analysts, banks and supervisory authorities. It has been argued – and this seems to be actually the case – that the methodologies for computing RWAs may not be comparable across institutions and, especially, across jurisdictions, and that they should more properly reflect risk in order to avoid ultimately jeopardising financial stability. These problems highlight the relevance of supervisory practices in determining banks’ capital requirements (for example, in validating internal banks’ models for calculating risk weights). Here, rigorous micro-prudential supervision is essential. We really need to work out a single rulebook, to move with determination towards taking joint responsibility and using peer reviews as much as possible in our supervisory activity. As for the initiatives to strengthen the regulation of the OTC derivatives market, these complex reforms are taking somewhat longer than originally planned. It is therefore necessary to pick up the pace, overcoming the difficulties of implementation and the industry’s resistance. Authorities must make all efforts to remove the uncertainties arising when transactions involve a cross-border dimension, which is a recurrent condition in a global market. This is necessary to pre-empt regulatory arbitrage and, ultimately, to achieve the G20 objectives. Work is also in progress on other relevant issues at an international level (capital requirements for exposures to central counterparties, margining standards for noncentrally cleared transactions, guidance on resolution of central counterparties, as well as on authorities’ access to trade repository data) and at a regional and national level. In Europe, at the end of next week a comprehensive set of standards for the implementation of the European Market Infrastructure Regulation will enter into force, complementing the European legal framework for the so-called “clearing obligation” embodied in the G20 statement of September 2009. From a global perspective, however, the regulatory effort needs to be carried out by the widest range of jurisdictions as made clear at the recent G20 meeting in Moscow. Significant efforts are also expected from the industry. The last FSB report on the implementation of the OTC derivatives market reform estimates that “approximately 10 per cent of outstanding credit default swaps and approximately 40 per cent of outstanding BIS central bankers’ speeches interest rates derivatives had been centrally cleared as of end-August 2012”.5 These shares should grow rapidly, so as to leave to customized OTC derivatives the sole purpose of meeting the specific hedging needs of financial and non financial counterparts which cannot be met by standardised, clearing-eligible contracts. It will be crucial to ensure that stricter regulation and supervision of banks will not push banklike activities and risks towards non – or less – regulated institutions (the so-called “shadow banking” sector). Let us not forget that the financial crisis originated in the US securitization market, largely populated by unregulated or scantily regulated operators. While we have to address bank-like risks to financial stability emerging from outside the regular banking system, the approach should be proportionate, focussed on those activities that are material to the system, using as a starting point those that were a source of risk during the crisis. The FSB is currently refining the set of recommendations issued in November of last year. One should bear in mind, however, that the new recommendations will be able to address the specific risks that arose during the crisis, and we all recognise the ability of the shadow banking sector to innovate. Although new regulations on systemically important financial institutions have recently been approved, the “too-big-to-fail” issue is still a major concern, and it merits strict monitoring. Some progress is being made in developing and testing methodology for the identification of global systemically important insurers (G-SIIs), and in developing appropriate supervision guidelines. An identification methodology for all non-bank financial institutions of global systemic relevance is also under preparation. For banking institutions (G-SIFI) the implementation of the framework recently agreed upon has much farther to go; we need to rapidly move forward. Negative externalities associated with banks’ behaviour (especially for large, interconnected financial firms) must be taken into account. A broad consensus has emerged on the idea that “macroprudential” policies directed towards preserving financial stability should limit systemic risk by addressing both the cross-sectional dimension of the financial system, with the aim of strengthening its resilience to adverse real or financial shocks, and its temporal dimension, to contain the accumulation of risk over the business or financial cycle. Moreover, given the complementarity between macroeconomic stability and financial stability, and that between the instruments to pursue them, the exchange of information and the co-ordination between macroprudential and monetary authorities are crucial to counter at the same time the risks for price stability and the systemic risks for financial stability. I would dare to say that proper understanding of how this can be effectively achieved is still in the making.6 Finally, even after the completion of the regulatory overhaul, it would be foolish to pretend that defaults can always be avoided. They may be the result of imprudent behaviour or of fraudulent operations. We need to be prepared for their occurrence, as the costs of public support tend to be very high. According to the latest data gathered by the European Commission, the outstanding amount of public recapitalizations as of June 2012 came to 0.1 per cent of GDP in France, 1.8 in Germany, 2.0 in Spain, 4.2 in the UK, 4.3 in Belgium, 5.2 per cent in the Netherlands, and over 40 per cent in Ireland. For Spain and Ireland these amounts are at their highest since 2008, in the other countries they are lower than the peaks reached in 2009. For the Spanish banks, a programme of recapitalization using European funds of up to €100 billion was authorized in July, of which €41 billion (3.9 per cent of GDP) has already been disbursed. In Italy, even taking into consideration the public support FSB, Fourth progress report on implementation of the OTC derivatives market reforms, 31 October 2012. P. Angelini, S. Neri and F. Panetta, “Monetary and macroprudential policies,” Banca d’Italia, Working Papers, 801, March 2011 (http://www.bancaditalia.it/pubblicazioni/econo/temidi/td11/td801_11/td_801/tema_801.pdf). See also P. Angelini, S. Nicoletti-Altimari and I. Visco, “Macroprudential, microprudential and monetary policies: conflicts, complementarities and trade-offs”, Banca d’Italia, Occasional Papers, 140, November 2012 (http://www.bancaditalia.it/pubblicazioni/econo/quest_ecofin_2/qef140/QEF_140.pdf). BIS central bankers’ speeches provided last month to the Banca Monte dei Paschi di Siena, public recapitalizations have been limited to 0.3 per cent of GDP. These figures indicate that the ongoing work on resolution regimes is very important in this regard, and rapid progress should definitely be made. This is particularly relevant in the euro area, where the new single supervisor mechanism (the SSM) is being implemented. Observations on the analytical implications of economic and financial instability Economic systems constantly evolve and transform. Changes in institutional arrangements, technological innovation and revisions in economic policy paradigms continuously reshape the framework in which economic agents (consumers and businesses) make their decisions. This in turn leads to changes in economic agents’ behavioural patterns. When there is marked discontinuity with the past, such changes may be far-reaching and the past fails to provide enough guidance for the present (never mind the future). We should always remember that the financial system is part of a richer social, economic and political environment. The real world is subject to shocks that at times may have dramatic consequences, such as those that we have experienced in the last twenty years or so, with the end of the cold war, globalization and the sudden emergence of new major economic actors, the ICT revolution, and substantial (not completely anticipated) demographic changes. However, a stationarity assumption of sorts underpins our theoretical and statistical models, in the case of economic forecasting and (macro) policy making as well as in the case of financial analysis and risk management. In general, the basic tenet is that future outcomes will be drawn from the same population that generated past outcomes, so that the time average of future outcomes cannot be persistently different from averages calculated from past observations and future events can be predicted with a certain degree of statistical accuracy. In non-ergodic environments, on the contrary, at least some economic processes are such that expectations based on past probability distribution functions can differ persistently from the time averages that will be generated as the future unfolds.7 In case of acute uncertainty, no analysis of past data can provide reliable signals regarding future prospects. The challenges posed by the non-ergodic nature of economic systems may be met by recognizing that our models are by necessity “local” approximations of very complex economic and financial developments. One needs to be modest, using theory and empirical models as starting points for, not straightjackets in, our decision making. And perhaps not enough attention has been paid by the financial community to the need for establishing institutional and behavioural norms to reign on patterns of instability and developing proper learning devices to deal with major shocks and regime changes. These challenges are compounded by another general characteristic of the quantitative analysis of economic phenomena: the difficulty of running parallel worlds, i.e. producing data through experiments designed and controlled by the researcher. Even when economic forces do follow repetitive patterns, it may not be easy to spot empirical regularities, because contingencies – especially the exceptional ones – cannot be re-created at will, in the laboratory, for cognitive purposes. Our experience will always be limited, partial and episodic. These aspects are not always taken into account in economics or finance. As Charles Kindleberger noticed: “For historians each event is unique. Economics, however, maintains that forces in society and nature behave in repetitive ways”.8 P. Davidson, “Is probability theory relevant for uncertainty? A Post Keynesian perspective”, Journal of Economic Perspectives, 5, 1, 1991. C. P. Kindleberger, Manias, panics and crashes: a history of financial crises, New York: Basic Books, 1989, p. 14. BIS central bankers’ speeches Why is it that the parameters and laws governing economic systems tend to change over time? A distinction can be made between exogenous uncertainty, when an individual’s actions do not affect the probability of an event occurring, and endogenous (or behavioural) uncertainty, when they do.9 In economic systems, this second type of uncertainty can be particularly important. This has not been sufficiently recognized, I believe, in the way (applied) macroeconomics and finance have evolved since the 1980s, with the ascendency of the rational expectations revolution in the former and the efficient market hypothesis in the latter. In macroeconomics this may have led to placing too much faith in the ability of dynamic stochastic general equilibrium (DSGE) models to represent or sufficiently approximate the real world on which economic policy is applied. These fundamentally linear models are the result of the intertemporal optimization by representative agents of objective functions under conditions of uncertainty, given technological and budget constraints and the “rationality” of their expectations (i.e. perfect foresight barring a random error). Indeed, going beyond the assumption that society and nature always behave uniformly and consistently over time has deep implications in policy making as well. This can be easily seen in monetary policy, where no mechanistic use of forecasting models can be made if one allows for the possibility of structural changes.10 An important lesson of the financial crisis – one that is generating substantial research activity – is that the interactions and feedbacks between the real and the financial sectors and the non-linearities that emerge especially during crises are not adequately captured by the available models. Many of the effects associated with financial and asset price imbalances are likely to be highly non-linear and complex. The reaction of monetary policy should then also be non-linear and it should respond to asset price misalignments and financial imbalances. When the probability of a crisis becomes non-trivial, the interest rate path towards ensuring monetary stability might be different than in ordinary circumstances. These aspects were not well captured in the empirical models used to support monetary policy decisions, something understood but perhaps not adequately recognized in discussions on flexible inflation targeting frameworks that took place a decade or so ago.11 One of my preferred quotes is from Herbert Simon:12 Good predictions have two requisites that are often hard to come by. First they require either a theoretical understanding of the phenomena to be predicted, as a basis for the prediction model, or phenomena that are sufficiently regular that they can be simply extrapolated. Since the latter condition is seldom satisfied by data about human affairs (or even by the weather), our predictions will generally be only as good as our theories. The second requisite for prediction is having reliable data about the initial conditions – the starting point from which the extrapolation is to be made. I. Visco, “On the role of expectations in Keynesian and today’s economics (and economies)”, translated from “Sul ruolo delle aspettative nell’economia di Keynes e in quella di oggi”, in Accademia Nazionale dei Lincei, Gli economisti postkeynesiani di Cambridge e l’Italia, Convegno Internazionale, Rome, 11–12 March 2009 (http://www.bancaditalia.it/interventi/intaltri_mdir/en_Visco_110309.pdf). See, among others, J. Vickers, “Inflation targeting in practice: the UK experience”, Bank of England Quarterly Bulletin, November 1998. See C. Borio and P. Lowe, “Asset prices, financial and monetary stability: exploring the nexus”, BIS Working Papers, 114, July 2002 (http://www.bis.org/publ/work114.pdf). See also C. Bean, “Asset prices, financial imbalances and monetary policy: are inflation targets enough?”, BIS Working Papers, 140 (with discussions by I. Visco and S. Whadwani, http://www.bis.org/publ/work140.pdf). H. A. Simon, The sciences of the artificial, MIT Press, Cambridge, Mass., 1972, p. 170. BIS central bankers’ speeches We must recognize that empirical models reflect historical experience in the values of their parameters and are mostly reliable when it is “business as usual”, that is, as long as our systems are not subjected to unusual pressure. It can be argued that their contribution to making informed decisions is limited, as they tend to become unreliable precisely when, following signs of structural discontinuity, the benefits of correct forecasting are greatest. Indeed, anomalous observations that do not fit the main mechanisms at work in the historical period used for statistical estimates are frequently put aside (“dummied-out”), their information content is neutralized. This is reasonable, as episodic observations of exceptional phenomena are generally inadequate to capture complex inter-relations between economic and financial variables. And yet those very deviations from the norm may contain precious information on how the economy works in conditions other than those usually prevailing. Much of the same reasoning applies to the analysis of financial market developments. The wave of financial innovation in the last two decades was fuelled by the idea, in principle correct and fruitful, that the proliferation of new (and complex) financial instruments, allowing agents to insure against many dimensions of risk, was a way to “complete the markets”, to get closer to the theoretical Arrow-Debreu world, enabling investors to transfer resources efficiently across time, space and states of the world. But this idea relied on the presumption that the world is basically stationary, that the future is pretty much the same as the past, that we can extrapolate from relatively small samples, and that there is a single “data generating process” that we can identify and understand. But we know that the real world is more complicated. The determinants of asset prices are not fixed, but vary over time. Asset returns do not follow a normal distribution, as it is assumed by conventional valuation formulas. Myopic behaviour, herding and other types of distorted incentives on the part of individuals and financial institutions can generate negative externalities and move financial markets’ expectations and risk premia away from fundamentals. And, lately, scholarly work has been attributing a new, enhanced role to psychological elements and the recognition that there are limits to what one can know. In the field of the so-called behavioural finance this may even go as far as to validate “irrational” actions. And eminent economists argue that these elements play a role in explaining both conservative attitudes and speculative bubbles.13 The potential limitations of quantitative analysis are therefore not limited to macroeconomics, econometric modelling and forecasting but also apply to finance. And they may have dire consequences. The case of the CDOs is instructive. These credit derivatives, that in the first half of the last decade recorded an impressive growth, were priced according to valuation models whose results were very sensitive to modest imprecision in parameter estimates and highly exposed to systemic risk (i.e. strongly affected by the performance of the economy as a whole).14 As a result, CDOs not only did not increase the risk bearing capacity of the economies, but their implosion between mid-2007 and mid-2008 was at the core of the global financial crisis. Innovative financial instruments with unsound theoretical foundations may exacerbate negative externalities and be sources of instability in their own right. Rather than in the development of unlikely “catch-all” models, the key to tackling the problems created by discontinuity must lie, first of all, in a better understanding of its nature and so in defining models in which the relations are based on parameters that remain stable in the long term. Research must therefore aim to identify sufficiently fundamental and reasonably dependable mechanisms that do not change over time. To provide sensible G. A. Akerlof and R. J. Shiller, Animal spirits: how human psychology drives the economy and why it matters for global capitalism, Princeton, Princeton University Press, 2009. See J. Coval, J. Jurek and E. Stafford, “The economics of structured finance”, Journal of Economic Perspectives, 23, 1, 2009. BIS central bankers’ speeches accounts of rational choices, quantitative models necessarily have to focus on systematic factors, and draw their own conclusions on the basis of key relations. In this respect it is worth recalling Bruno De Finetti’s argument for a “theory of finance”, made as early as 1957:15 In order for a theory of behaviour to say something, it must necessarily be restricted to that which is derived as the consequence of a few main concepts and criteria and which can accordingly (if somewhat arbitrarily) be defined as “rational behaviour”. Then the theory will set out conclusions that are valid in the absence of accessory factors. This is not to deny or downplay the possible presence or importance of such factors; only, it is preferable to shift the study of deviations from the “theoretical” behaviour implied by those conclusions to a later moment and to the detailed plane of complementary observations, rather than cloud all distinctions in a single theoretical construct which, in the attempt to embrace and set on an equal plane the congeries of systematic and accessory factors, would be reduced to a non-theory suitable solely to conclude that all kinds of behaviour are equally possible (for caprice or madness, even, as is in fact the case). Obviously, De Finetti’s “later moment” should not be overlooked in applied research. Against the risk that the theoretical paradigms underlying the approximation of reality implicit in a model may prove particularly inadequate in certain situations, it is useful to employ a battery of different models and cross-checks. This “multi-pronged” approach to modelling and forecasting also makes it possible to more effectively filter and interpret the great mass of partial and fragmentary or even contradictory data that gradually become available. But in dealing with non-ergodic processes, what really is all the more essential is to integrate the signals provided by quantitative models with information outside the models, take stock of related historical experience in its entirety, and intervene on the basis of both theory and good sense. In both empirical microeconomics and finance work is under way to deal with the issues that have been considered here. Deviations from the assumption of normal distributions, “fat tails” and the modelling of extreme events are being taken into account both in research and applications. And it should be recognized that the importance of human behaviour does not imply that economic systems necessarily have to be prone to instability. In fact, the very existence of behavioural uncertainty may tend to create a set of institutions, as well as conventions and habits, which help to deal with the problems highlighted in Keynes’ “beauty context” example and ensure the stability of the main economic processes, as emphasized by Herbert Simon.16 Still, I believe, more attention should be paid to how to account for learning in the crucial adjustment periods that follow extreme events that cannot be simply taken as random extractions from a stable, even if non-normal, probability distribution. Widening the class of probability distributions remains however, for the time being, the practical response to phenomena such as the ones we have been dealing with in this difficult period. Final remarks The crisis has shown that benign neglect should never have been an option. It has called for a major overhaul of the regulatory and supervisory financial framework, especially at an international level. In a globalized financial marketplace, with large and powerful participants, individual action by national authorities would be bound to fail. By the same token, the B. De Finetti, Lezioni di matematica attuariale, Roma: Edizioni Ricerche, 1957, p. 71 (my translation). H. A. Simon, “The role of expectations in an adaptive or behavioristic model”, in M. J. Bowman (ed.) Expectations, uncertainty and business behavior, New York, Social Sciences Research Council, 1958. BIS central bankers’ speeches boundaries of supervision should be widened to encompass all relevant intermediaries, regardless of the specific industry sector they belong to. I have discussed the work underway, highlighted the results achieved and stressed the areas where more effort is needed. The correct conduct of credit and financial business also requires competence and good faith on the part of intermediaries, both factors being decisive to ensure sound and prudent management and preserve the confidence of savers. This necessity is heightened by the complexity of the external environment, by the presence of large intermediaries, and by the economic and reputational damage that can result from illicit behaviour. No market can function without rules, nor is prudent management possible without correct conduct, embodied not only in scrupulous compliance with the law and the supervisory rules but also in complete adherence to business ethics. The dramatic events of the past five years have highlighted the limitations of modelling and quantitative analysis in finance and in economics. The common assumption of stationarity is at odds with the unpredictably changeable nature of the real world. This is not to say that all the analytical efforts of the past and the progress achieved should be disregarded. It means rather that in order to make the best out of them one needs to remember that models are by necessity “local” approximations to very complex phenomena and they should be used with good sense as a framework, not a straightjacket, for our decision-making. Quantitative analysis and modelling can also help to establish institutional and behavioural norms to rein in patterns of instability and developing proper learning devices to deal with major shocks and regime changes. In turn, models should take into account the impact of such norms on economic developments. Central banks have a crucial role to play. There are clear complementarities between financial and monetary stability. Sometimes these are formally recognized in their official mandate, but even when this is not the case, central banks must take them into account in their policy decisions. In this respect, I would like to quote from a book by the brilliant Bank of Italy economist Curzio Giannini, who passed away prematurely about ten years ago. In that “beautifully written and illuminating” work, as Charles Goodhart describes it in his foreword, Curzio clearly saw the likely consequences of financial developments, and concluded:17 In the years to come, the most interesting developments will probably be precisely in the sphere of supervision and regulation. […] Whatever its detractors may say, the central bank has no need to move into new lines of business. Capitalism generated the central bank and capitalism will come to it again, even if the current infatuation with the financial markets’ self-regulating capacity were to endure. […] The central bank produces an intangible but essential good – trust – of which capitalism (based as it is on a pyramid of paper if not mere electronic signals) has an immense need. We must not forget that trust, or its synonym “confidence”, derives from the Latin fides, meaning faith, which cannot be produced simply by contract. In fact the legitimacy of central banks does not lie in their policy activism, or the ability to generate income, or even, save in a highly indirect sense, their efficiency. Rather, […] it derives from competence, moderation, the long-term approach, and the refusal to take any tasks beyond their primary role. If, as I am sure, there is another phase in the development of central banking, it will spring from these values. In the end this is, perhaps, what society should expect, if not from the financial sector, from those who are called to look after financial stability. C. Giannini, The age of central banks, Cheltenham, UK, Edward Elgar, 2011, p. 255 and pp. 258–259, English translation, L’età delle banche centrali, Bologna, Il Mulino, 2004. BIS central bankers’ speeches | bank of italy | 2,013 | 3 |
Remarks by Mr Fabio Panetta, Deputy Director General of the Bank of Italy, at a colloquium entitled "Beyond the crisis: What lies in store for Italian banks?", by Associazione per lo Sviluppo degli Studi di Banca e Borsa in collaboration with Università Cattolica del Sacro Cuore of Milan, Perugia, 23 March 2013. | Fabio Panetta: Banks, finance, growth Remarks by Mr Fabio Panetta, Deputy Director General of the Bank of Italy, at a colloquium entitled “Beyond the crisis: What lies in store for Italian banks?”, by Associazione per lo Sviluppo degli Studi di Banca e Borsa in collaboration with Università Cattolica del Sacro Cuore of Milan, Perugia, 23 March 2013. * * * The Italian economy is going through a very difficult period, in which structural weaknesses have been compounded by adverse cyclical conditions. In the last five years, we have had to deal with the financial crisis, instability in the sovereign debt market and a severe double-dip recession. Since the start of the crisis, GDP has fallen by 7 per cent and 600,000 jobs have been lost. Thanks to sound initial conditions, the Italian banking system has been able to withstand the succession of real and financial shocks, benefiting from prudent supervision, which has reassured international investors as to the quality of banks’ balance sheets and averted the destabilizing surge that has hit other European financial systems. Nonetheless, Italian banks could not avoid the indirect repercussions of the crisis: the recession affected loan quality; the deterioration of sovereign debt ratings dried up the sources and increased the cost of funding; profitability fell dramatically. This affected the supply of credit, which has tightened in recent months. The latest data, for January, indicate a twelve-month contraction in lending to firms of around 3 per cent. The exceptional measures taken by the Eurosystem in 2011 and 2012 stopped the liquidity crisis from turning into a credit crunch, with ruinous consequences for the real economy. Tensions are now concentrated on loan quality: bad loans account for 6.9 per cent of total lending, while all deteriorated credit amounts to 12.8 per cent (3.3 per cent and 8.4 per cent, respectively, net of value adjustments). The impact on earnings is substantial: in the three years 2009–11 write-downs and loan losses absorbed 60 per cent of operating profit on average. The economic cycle forces banks to take high lending risks, which must be covered by their reserve assets. The Bank of Italy is checking, including by means of on-site controls, the adequacy of the value adjustments made by a great number of large and medium-sized banking groups and, where necessary, requiring corrective action. The preservation of a satisfactory level of provisioning allows banks to maintain investor confidence and attract low-cost external funding. This is essential to continue to guarantee an adequate flow of credit to households and firms. In order to avoid procyclical effects, in connection with this action the Bank of Italy has asked banks to increase internally-generated resources by cutting costs, selling non-strategic assets, and adopting dividend policies consistent with their individual income and balancesheet position. The criteria for the remuneration of directors and executives must also be consistent with the aim of capital strengthening, giving a clear indication of company strategy. Beyond the short term, the recovery of banks’ profitability and the strengthening of their capacity to serve the real economy will require profound changes to their business model. In the following pages I will examine two topics of particular importance for the Italian banking system. The first regards the need to encourage firms to access the capital markets directly. Conditions are now favourable for both banks and firms to work for this objective to their profit. BIS central bankers’ speeches The second regards the need to shift more decisively, through technology, the traditional distribution channels towards more advanced systems, achieving a substantial reduction in operating costs. * * * In the last few weeks uncertainties over prospective developments in the Italian economy have resurfaced. The quite moderate recovery forecast for late this year is now threatened by the unpredictability of the domestic political situation and the resurgence of financial turmoil in the euro area, which could undermine confidence and investment. In order to preserve the prospective recovery, action to support business activity is necessary. If taken promptly, the measures now under discussion for the payment of general government debts to suppliers will be of considerable help. However, there cannot be an enduring recovery without adequate financial support. Banks are called on to make an essential contribution: to continue providing the credit needed to sustain economic activity; to accompany firms with good growth prospects in raising funds on the market; to serve, once more, as a focal point for revitalizing the Italian economy. The structure of the financial system and the financing of firms The Italian banking system is comparatively small with respect to the real economy. Its total assets amount to 2.7 times GDP, significantly less than in the other major countries except for the United States (Figure 1). Nevertheless, the banks play a pre-eminent role in the financing of firms. Bank loans made up over two thirds of Italian firms’ financial debt, compared with about a third in France, Britain and the United States and half in Germany. Italy is the only major country in which this share has increased since the onset of the crisis (Figure 2). By contrast, the Italian capital market plays a limited role in financing enterprises. Firms’ equity endowment in Italy is not unlike that in other countries. Financial leverage,1 at about 50 per cent, is broadly on a par with that of firms in Japan, Germany and the United Kingdom and higher than in the US and France. But about four fifths of shares are held and traded outside the official markets. Stock exchange listing is circumscribed to a few large firms. Considering non-financial corporations only, in 2012 Italy counted 230 listed firms, compared with about 700 in France and Germany. The median firm in Italy had a market capitalization of about €90 million, twice as much as in those two countries. The total market value of Italy’s non-financial corporations is less than 20 per cent of GDP, compared with 75 per cent in France and 45 per cent in Germany (Figure 3). Bond financing is also limited, outstanding issues now amounting to less than 8 per cent of firms’ total financial debt (Figure 4). Just a few Italian corporations make bond issues on the capital market (an average of ten a year over the past decade). Here, again, Italy lags significantly behind, and in recent years the gap has widened (Figure 5).2 The same pattern holds for other instruments of direct or indirect recourse to the market, such as asset securitizations. This type of financial system – bank-dependent, lacking well-developed equity and bond markets, incapable in practice of offering the productive economy any resources other The ratio of financial debt to financial debt plus shareholders’ equity at market prices. In the four years from 2009 through 2012 bond issues by Italian non-financial corporate groups on the international markets were negligible, while those by French and German groups were large and growing. BIS central bankers’ speeches than bank credit – is especially disadvantageous in the present cyclical phase. It penalizes firms, especially the smaller ones, because it prevents them from coping with the tightening of credit supply by replacing bank loans with other instruments. And it penalizes banks as well, saddling them with very high costs and risks. What is more, the strains in credit supply aggravate the difficulties of firms and feed back onto the banks’ own balance sheets through heightened credit risk and defaults. The scant presence of Italian firms in the capital markets is a well-known problem, rooted in the structural weaknesses of the economy. First of all, it reflects the response to the incentives of firms themselves. They are, in fact, reluctant to open themselves to outsiders. Expansion and access to the markets entail potentially significant transparency costs owing to increased visibility (to the tax authorities, to regulators, to minority shareholders), an excessive tax burden, a plethora of inefficiently applied rules and regulations, and the poor flexibility of the goods and labour markets.3 One consequence of the small average size of Italian firms is low demand for such financial services as listing assistance, securities issues, and syndicated loan placement. These are services that are used heavily by large corporations but very little by small firms, which are inherently less transparent, have few shareholders and are generally not present in the capital markets. In the past, repeated efforts have been made to draw Italian firms to the stock market by reducing the cost of listing, offering tax breaks for listing or share issues, and instituting stock exchange segments dedicated to small and innovative businesses. Action has been taken to raise disclosure standards, enhance the liquidity of securities and improve the quality of governance. The results have been disappointing. At times, banks too have imagined that they could profit from the underdevelopment of the markets. Firms’ dependence on credit reduces their bargaining power, enabling banks to impose better terms for lending. The limited empirical evidence on this point suggests that listed firms and firms that issue bonds on capital markets pay lower interest rates. These findings apply also to large corporations, which are the least likely to be “captured” by their banks.4 Growth of the markets: a possible change An under-developed capital market and the productive system’s reliance on bank lending have thus been the short-sighted response of Italian firms and banks to incentives. Accordingly, they have been a typical feature of our financial system. The financial crisis, the sovereign debt tensions, and the economic recession are changing those incentives, however, and may initiate a shift in the methods of financing Italian business. On the one hand banks are being forced to reduce the overall size of their balance sheets in response to both cyclical and structural factors, such as the new capital and liquidity regulations, market pressures to reduce leverage, the high cost of funding, large credit risk, and low profitability. The credit supply tensions that have arisen on several occasions in recent months are a reflection of these factors. On the other hand firms have seen their scope for self-financing diminish and the volume of overdue payments from general government sky-rocket. In such a situation, even healthy businesses need to be able to count on the availability of sufficient external sources of financing. M. Pagano, F. Panetta and L. Zingales, “Why Do Companies Go Public?” Journal of Finance, LIII, No. 1, 1998, suggest that the relative underdevelopment of the Italian stock market depends on firms’ unwillingness to accept the obligations of transparency that listing entails. The impact of listing on the cost of credit is studied in Pagano, Panetta and Zingales, op. cit. The effect of bond market access on the interest rates on bank loans is studied in F. Panetta, 2001, “Le banche e i servizi finanziari alle imprese”, address to the conference La concorrenza nell’offerta di servizi finanziari: mercati, banche e altri operatori, Associazione per gli studi di Banca e Borsa, SADIBA. BIS central bankers’ speeches This dangerous stalemate – the combined effect of a reduced supply of credit and the productive system’s increased dependence on external finance – can be overcome by enlarging direct recourse to the markets, with considerable benefits for firms and banks alike. In the present phase of the cycle, the benefits for firms of being able to access otherwise unavailable funds outweigh the costs of disclosure. The advantages of diversified sources of funding, greater negotiating power in raising bank loans, and the reputational gain that comes with access to the markets are another inducement towards openness and transparency. Expanding the sources of funding requires a major commitment by businesses to increase the transparency of their financial statements, take concrete steps to open up to outside parties, and strengthen their capital base as a sign of confidence in the company’s soundness. It is unrealistic to suppose that today’s markets would be willing to support opaque or under-capitalized projects. The potential benefits are considerable for banks as well. To begin, chaperoning businesses in the market would allow banks to avoid the deterioration in credit risks that rationing their clientele might otherwise entail and to increase income from business services, which remains under-developed. By providing the consulting services that are crucial for firms’ direct funding and that imply low capital and liquidity absorption, the banks could strengthen, not weaken, their relationships with firms, as well as their role in a more articulated financial system. For greater recourse to the market to be possible banks must enter into long-term relationships with firms and improve their ability to evaluate the latter’s economic and financial prospects. The task is not an easy one, and in the past it was not carried out in full. Steps must be taken to improve staff training and increase their ability to help firms access the markets, and to prevent conflicts of interest within the banks stemming from their combined role in granting credit, promoting market access and (directly or indirectly) managing household savings. Fears that the banking system plans to transfer the cost of past lending errors to the market must be dispelled. Even the riskiest borrowers can be helped to access the market if potential financiers can rely on the transparency they need to make informed decisions. Unless these conditions are fulfilled, banks’ reputations and their clients’ confidence will be undermined. Banks and firms are not the only ones responsible for developing the Italian capital market. To achieve this objective the whole economic and financial system must undergo changes to stimulate long-term investors such as pension funds, provide incentives for investment in venture capital, and eliminate the fiscal and administrative constraints that discourage firms from growing in size. Banks and firms have a crucial role to play, however. It is up to them to pave the way for change. Technology and banks’ distribution costs Italian banks’ profitability has fallen significantly during the crisis. Between 2006 and 2011 their annual profit declined by more than 30 per cent as a result of a steep drop in income together with a slight rise in costs (Figure 6). The deterioration was concentrated among the largest groups, which saw their annual profit decline by 46 per cent as they recorded a reduction in operating costs (down by 9 per cent) but an even sharper contraction in gross income (Figure 7). The other banks registered a slight rise in profits (up by 1.6 per cent), despite an increase of 17 per cent in costs. Profitability remained low in 2012 as well. BIS central bankers’ speeches The current levels of profitability are insufficient to remunerate capital adequately. In the absence of incisive action, they threaten to weaken banks’ capitalization, their capacity to finance the recovery of the real economy. In the 1990s the rebound in bank profitability came about principally through an expansion of income, with only modest interventions on costs (Figure 8).5 In the present circumstances, an increase in revenues appears unlikely considering the stagnation in lending, narrow profit margins, the downward trend of asset management and the penalization of trading activity implicit in the new capital rules. Overall, the Italian banking system seems to have an excess of capacity, which drives down the overall volume of business. In the short term, therefore, raising profitability requires energetic action on the cost side, with an unflinching review of the combination of production factors and distribution channels. While the demand for banking services has grown slowly in the last twenty years, the number of bank branches has nearly doubled. Gauged against the euro-area average, it is excessive in relation both to total bank assets (€111 million per branch in Italy against €170 million in the euro area) and to the volume of loans (€59 million against €67 million).6 Until the start of the financial crisis, the increase in the number of branches went together with an expansion of virtual distribution channels (Figure 9), rapidly growing investment in information and communication technology (ICT) (Figure 10) and stable staff size. The crisis has only attenuated these trends. The use of technology and remote distribution has thus largely overlapped, not replaced, the utilization of labour and the traditional branch network. The cost-income ratio has not come down; on the contrary, up to 2011 it increased. Massive recourse to ICT can reverse these trends through synergistic use of the different distribution channels (branches, telephone, call centres, ATMs and the Internet), according to the practices followed by the intermediaries that have become international success stories. Remote channels can be used for the distribution of highly standardized, low-valueadded transaction-based services, such as liquidity management and consumer finance products, especially to the more technologically or financially advanced customers. This would permit the drastic pruning of the traditional distribution network and would free up the resources needed to strengthen the remaining branches, focusing their activity on more complex or advisory-intensive products, such as corporate banking, mortgage lending and wealth management, that can generate more value added and reinforce customers’ preference for one-stop shopping. Recent analyses suggest that the result could be a reduction in costs of as much as 30 per cent in the medium term.7 A transformation along these lines is no easy task. It will require changes to banks’ organization and operating arrangements in order to acquire the necessary technological knowledge, ensure integration among the different distribution channels and train staff to perform new tasks. The business plans of the main listed banking groups do not always appear to be consistent with the above-mentioned objectives. In a number of cases, efficiency gains and productivity increments are based on restructuring of the territorial network and containing the number of staff, without envisaging progress towards multi-channel distribution. For the D. Focarelli, F. Panetta and C. Salleo, “Why Do Banks Merge?”, Journal of Money, Credit and Banking, Vol. 34, No. 4, November 2002, pp. 1047–66. It is in line with the euro-area average in relation to population (one branch per 1,800 inhabitants). See McKinsey&Company, “Day of reckoning for European retail banking”, 2012. BIS central bankers’ speeches few groups that publish complete information on the subject, investment in ICT is limited in amount and allocated mainly to optimizing existing information systems rather than developing virtual channels. In many cases the resources devoted to staff training are modest as well. Large-scale use of remote channels requires, above all, full confidence on the part of customers. Its absence precludes, for example, the distance marketing of high-unit-value products such as mortgages and retirement savings products. In recent years significant efforts have been made to improve the quality and transparency of communications between banks and customers. The Bank of Italy has laid down rigorous rules, checking compliance in part through inspections at bank branches. Progress has been made, no doubt, but there is still considerable room for improvement, not only in the process of compliance with the large and diversified body of rules but also in actually partaking of the spirit that animates the regulations on transparency and correct conduct. Going forward Greater recourse to the market by firms and cost cutting are in banks’ interest; they are essential for the financing of the real economy. However, they are not the only measures needed to adapt intermediaries’ business model to the changes brought about by the financial crisis. Looking ahead, we must ask what will be the impact of the radical changes that have occurred in the regulatory framework, the financial system and the behaviour of investors. The events of recent years have clearly (though sometimes tardily) revealed the elusive nature of economies of scale and scope in banking,8 giving renewed impetus to the debate on the optimal size of intermediaries and the range of activities that can be performed simultaneously by any one banking group. The rules adopted or under discussion in the main countries, designed to separate traditional credit business from investment banking,9 are likely to lead to a radical change in the operating structure of the largest groups. Their application deserves to be carefully assessed. Faced with growing recourse to the markets and globalization, it will be necessary to find innovative ways to establish lasting credit relationships with customers, to follow firms in their international expansion and support their success in outlet markets, and to strengthen the supply of products and services to households at conditions that are advantageous for both savers and banks in an environment of low interest rates. To provide answers to these and other questions, it is essential that there be a continuous exchange between authorities, practitioners and scholars to compare theoretical precepts and institutional knowledge with experience in the field. It is to be hoped that this meeting will make a significant contribution to this search for understanding. Doubts about the existence of economies of scale and scope are raised in D. Amel, C. Barnes, F. Panetta and C. Salleo, “Consolidation and efficiency in the financial sector: A review of the international evidence”, Journal of Banking and Finance, 28, pp. 2493–2519, 2004. For a survey of the recent literature, see also R. DeYoung, “Modeling Economies of Scale in Banking: Simple versus Complex Models”, mimeo, University of Kansas, 2012. The reference is to the Volcker rule in the United States, the Vickers report in the United Kingdom and the Liikanen report in Europe. BIS central bankers’ speeches Figures Figure 1 FINANCIAL ASSETS OF THE BANKING SYSTEM (MFIs) IN RELATION TO GDP 12.0 10.0 8.0 Germany France 6.0 Italy United Kingdom United States 4.0 2.0 0.0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Sources: Bank of Italy and Istat for Italy; Eurostat and ECB for the euro-area countries; Central Statistical Office and Bank of England for the United Kingdom; Federal Reserve System and Bureau of Economic Analysis for the United States. Figure 2 RATIO OF NON-FINANCIAL CORPORATIONS’ BANK DEBT TO THEIR FINANCIAL DEBT Percentages Italy France Germany United Kingdom United States Sources: Bank of Italy for Italy; Eurostat and ECB for the euro-area countries; Bank of England for the United Kingdom; Federal Reserve System for the United States. (1) Bank debt comprises only the loans disbursed by the banks resident in each country. (2) 2011 data. BIS central bankers’ speeches Figure 3 STOCK MARKET CAPITALIZATION OF NON-FINANCIAL CORPORATIONS As a percentage of GDP Italy France Germany United Kingdom United States Source: Based on Datastream data. Figure 4 RATIO OF NON-FINANCIAL CORPORATIONS’ BOND ISSUES TO THEIR FINANCIAL DEBT Percentages Italy France Germany United Kingdom United States Sources: Bank of Italy for Italy; Eurostat and ECB for the euro-area countries; Bank of England for the United Kingdom; Federal Reserve System for the United States. BIS central bankers’ speeches Figure 5 NON-FINANCIAL GROUPS: RECOURSE TO THE INTERNATIONAL BOND MARKET BY COUNTRY OF RESIDENCE OF THE PARENT COMPANY Number of groups issuing bonds Gross issues Semi-annual data Yearly data, billions of euros 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 20 20 20 Germany Spain France Italy 1_ 2_ 5 1_ 5 2_ 6 1_ 6 2_ 7 1_ 7 2_ 8 1_ 8 2_ 9 1_ 9 2_ 0 1_ 0 2_ 1 1_ 2_ 2 United Kingdom Germany Spain Italy United Kingdom France Source: Based on Dealogic data. Figure 6 BANK INCOME AND COSTS: CONTRIBUTIONS TO GROWTH 2006-11 Gross income (-13.55%) Operating costs (+ 1.60%) -2 Administrative expenses -4 Other staff costs -6 Wages and salaries -8 Fee income and other revenues -10 Net trading income -12 Net interest income -14 Source: Bank of Italy, supervisory reports. BIS central bankers’ speeches Figure 7 GROWTH RATES OF GROSS INCOME AND OPERATING COSTS BY SIZE OF BANK 2006-11 5 largest groups large small minor Gross income Operating costs -10 -20 -30 -40 Source: Bank of Italy, supervisory reports. Figure 8 BANK INCOME AND COSTS: MEDIUM-TERM DYNAMICS Index numbers (2000=100) of the series at constant prices (left-hand scale) and percentages (right-hand scale) Cost-income ratio (% ) Gross income Operating costs Source: Bank of Italy, supervisory reports. BIS central bankers’ speeches Figure 9 DISTRIBUTION CHANNELS Percentage of households’ current accounts (left-hand scale) and units (right-hand scale) Branches (righthand scale) Households with remote banking transaction capabilities Households with phone banking transaction capabilities Source: Bank of Italy, supervisory reports. Figure 10 BANKING INDUSTRY FACTORS OF PRODUCTION Thousands of units (left-hand scale) and millions of 2005 euros (right-hand scale) Staff IT investments deflated using the BEA index 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: Bank of Italy, supervisory reports. BIS central bankers’ speeches | bank of italy | 2,013 | 4 |
Opening address by Mr Ignazio Visco, Governor of the Bank of Italy, at the IFSB Forum "The European challenge", organized by the Islamic Financial Services Board (IFSB) and hosted by the Bank of Italy, Rome, 9 April 2013 | Ignazio Visco: Islamic finance and the European challenge Opening address by Mr Ignazio Visco, Governor of the Bank of Italy, at the IFSB Forum “The European challenge”, organized by the Islamic Financial Services Board (IFSB) and hosted by the Bank of Italy, Rome, 9 April 2013. * * * Ladies and gentlemen, I am pleased to welcome you today to this Seminar, organized by the Islamic Financial Services Board and hosted by Banca d’Italia on the subject of Islamic finance. As you know, the main prescriptions relating to financial transactions in accordance with Islamic religious law are the ban on paying interest and the prohibition of excessive uncertainty and speculation in contractual arrangements. This is predicated on the principle that profits should be generated from fully sharing in the business risk of an investment (the so called “profit and loss sharing principle”). The asset-backing requirement complements these prescriptions, providing for the link between each financial transaction and an identifiable underlying asset. A few weeks ago I gave a lecture on the financial sector after the crisis. On that occasion, it occurred to me that the renowned economist and philosopher – and eventually Nobel laureate – Amartya Sen had given in these same rooms the first of our scholarly lectures entitled to the memory of our late governor Paolo Baffi. Sen’s lecture was on “Money and Value: on the Ethics and Economics of Finance”. It is of course an interesting and good read in these difficult days. But what I was most intrigued by was Sen’s question: “How is it possible that an activity that is so useful has been viewed as morally so dubious?” There are indeed a good finance and a bad finance. While we may have some differences in ideas and perceptions on the goods and the bads, I think that what is most important is really to focus on the link between financial transactions and underlying assets, to conclude, with Sen, that “finance plays an important part in the prosperity and well-being of nations”. Indeed, it is crucial for sharing and allocating risk, especially for poorer societies and people. It is crucial for transferring resources over time and removing liquidity constraints. It is very important for fostering innovation and promoting economic growth. But it has to be certainly “ethical” and certainly transparent. An accurate measure of Islamic financial services is difficult, due to the lack of official statistics. However, some private estimates assess the current size at about 1.6 trillion dollars, in terms of assets. While Islamic finance still constitutes a small share of the industry, roughly 1 per cent of overall global financial assets, it has witnessed a rapid expansion over the last decade, with annual growth rates in the range of 10–15 per cent. It has also gained further momentum following the financial crisis. Islamic banking accounts for about 80% of total Islamic financial assets but the development of Islamic securities, notably the sukuks, has also contributed to increasing this sector’s activity in international capital markets. The industry has seen a wide dissemination across countries, beyond its traditional centres of gravity in the Middle East and South East Asia. According to available estimates, Islamic financial institutions are currently operating in around 70 countries. Europe has also been part of the process, with the opening of Islamic banks in the UK, the issuance of a sukuk bond by a German Land, an increased activity in the field of Islamic investment funds, some tax and regulatory changes introduced in France to facilitate the use of Islamic financial products. BIS central bankers’ speeches This global expansion is expected to continue also in the near future: some market estimates foresee that by the end of this year Islamic financial assets will have reached 1.9 trillion dollars. Several factors underlie growth in this sector: the need to invest the abundant liquidity acquired by oil exporting countries; the search for risk diversification and for shari’ah compliant/ethical investments; the increased need for funding for socio-economic development in Islamic countries; and support from regulatory and supervisory authorities. Part of this trend can also be attributed to the growing interest in the industry coming from non-traditional markets, like the EU, the US, South Korea, Hong Kong, etc. In Banca d’Italia we are interested in deepening our knowledge of this subject, in view of its relevance for the Bank’s institutional duties, as a member of the Eurosystem and as the Authority for banking and financial supervision in Italy. A Seminar on Islamic Finance was organized here in 2009 and a collection of research papers on Islamic finance vs. conventional financial systems, focusing on supervision and the implications for central banking activity was published in 2010. Hosting this IFSB seminar is a fruitful occasion to further improve our knowledge and to share it with our financial community and academia. The opportunity to attract foreign capital to underpin economic progress, on the one hand, and the intensity of the commercial and financial links with the southern shores of the Mediterranean, on the other, make it increasingly important for our country and its financial system to be equipped with the knowledge and the operational instruments needed to interact with financial systems complying with shari'ah principles. It is interesting to note that in the countries where Arab revolts occurred and Islamic-oriented political parties are now in charge of government, after the collapse of previous authoritarian regimes, the development of Islamic finance is gaining momentum. Very recently the Egyptian Legislative Council has adopted a project to issue sukuk. Even a cursory look at today’s program shows that Islamic finance and its interactions with conventional financial practices are a source of numerous intriguing questions. I am therefore confident that the subject will stimulate the interest of participants, and most grateful to the speakers who have accepted to join the 4 panels. The overview of the industry, to which Session 1 is devoted, will show that the growth of Islamic finance in recent years is one aspect of the increased role being played in the global financial system by a number of emerging economies. This opens up new opportunities for channeling financial resources both to these countries and other markets but it also adds to the complexity of the system, calling for enhanced international cooperation by policymakers and regulators, lest the benefits of a financial system which is dynamic and prone to healthy innovation are jeopardized by instability. In the European context, some additional drivers can be identified: on the demand side, the growing resident Muslim community potentially requesting more retail banking services, and on the supply side, an improved know-how on the part of European intermediaries, together with the already mentioned attractiveness of some financial markets for the investment of Gulf countries’ liquidity, and the potential use of Islamic finance products to broaden funding sources to finance public debt. The question of public debt financing takes us to the subject of another Session – Session 3 – where the issuance of sukuk bonds, whose total outstanding volume reached $230 billions in 2012, will be discussed, together with their increased role in international capital markets. Growing attention is devoted in Europe to the possibility of issuing sovereign and corporate sukuk and we are pleased to have as Chairperson of this session Ms. Maria Cannata, Director General of the Public Debt, Department of the Treasury of our Ministry of Economy and Finance. Coming to challenges and opportunities in the European framework, which will be discussed in Sessions 2 and 4, let me conclude by only mentioning in passing some issues that may BIS central bankers’ speeches inhibit the development of Islamic finance. First, in the field of monetary policy, the Eurosystem operational framework is, of course, relying on interest-based instruments. Second, in the area of prudential regulation and supervision, all European banks have the obligation to join deposit insurance and/or financial services compensation schemes, whereas, according to the Islamic jurisprudence prevailing in various Islamic countries, Islamic bank “investment” deposits (which follow the “profit and loss sharing principle”) cannot be covered by deposit guarantee schemes. Moreover, there exists a prominent issue of corporate governance related to the role of the shari’ah boards. In Italy for instance the Board of a bank is required to take full responsibility for the bank’s management decisions, which cannot obviously be “shared” with another body such as the shari’ah board. Let me leave you with these queries trusting that the debate in this forum will shed light on the issues. BIS central bankers’ speeches | bank of italy | 2,013 | 4 |
Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the conference "Twenty years of transition - experiences and challenges", hosted by the National Bank of Slovakia, Bratislava, 3 May 2013. | Ignazio Visco: The impact of the crisis on financial integration in Central and Eastern Europe Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the conference “Twenty years of transition – experiences and challenges”, hosted by the National Bank of Slovakia, Bratislava, 3 May 2013. * * * I wish to thank for useful discussion and help Emidio Cocozza, Paolo Del Giovane and Valeria Rolli. Introduction The global financial crisis has been severe and widespread, affecting different economies in different and long-lasting ways. The transition countries of Central and Eastern Europe1 have been no exception: their quite rapid financial integration over the past twenty-years has brought enduring economic benefits but also left them relatively more exposed to the global financial turmoil, through their links with Western European banks, which hold dominant stakes in the region’s markets. Financial stability has become a fundamental objective of policy-making once again, and central banks are heavily involved in this endeavor, which calls for a thorough overhaul of financial regulation and supervision. Tomorrow’s financial system will be different from the one that has developed over the last two decades. Global financial integration during the past decade In the decade before the financial crisis the financial system grew dramatically in size, and its role and pervasiveness in the economy increased in comparable measure. Since the advent of the crisis, this process has not been interrupted but only slowed down. In the euro area, the total financial resources collected by the private sector (bank credit, bonds issued domestically and stock market capitalization) rose from 160 per cent of GDP in 1996 to 240 per cent in 2007, before slipping to 230 per cent in 2011. A similar pattern is found for the United States, where over those same years the ratio rose from 230 to 330 per cent and then declined to 260 per cent in 2011 (Figure 1). Driven by the revolution in information and communications technology and by the process of financial integration, there was a considerable expansion in the supply of derivatives products, the securitization of banks’ assets, and so-called structured financial instruments. The total outstanding notional amount of over-the-counter and exchange-traded derivatives rose from about 94 trillion U.S. dollars at the end of 1998 to around 670 trillion dollars at the end of 2007 and has hovered around that level since (Figure 2). An important aspect of this process has been international financial integration. In the last decade industrial countries’ gross external financial assets and liabilities more than doubled in proportion to GDP, reaching 440 per cent at the end of 2007 (Figure 3). Financial market development in the emerging economies has also been dramatic. Total financial resources collected by the private sector (outstanding stocks of bank credit, domestic debt securities and equity market capitalization) increased from about 120 to 230 per cent of GDP between 1996 and 2007 for the emerging Asian economies as a group, and from about 40 to almost 100 per cent for the countries of Central and Eastern Europe I refer to the new Member States of the European Union in Central and Eastern Europe. I also consider Slovenia, Slovakia and Estonia, which joined the euro area in 2007, 2009 and 2011, respectively, insofar as the main focus is on international financial integration from the perspective of transition countries. BIS central bankers’ speeches (Figure 4).2 International financial integration – with foreign direct and portfolio investment and the involvement of foreign banks in domestic financial systems – was boosted by the overcoming of a series of obstacles: macroeconomic instability, vulnerable external positions and inefficient institutional and regulatory setups. Since the mid-2000s, this process has been greatly furthered by exceptionally favorable global financial conditions, with abundant liquidity, low risk aversion, and falling long-term interest rates. Financial integration in Central and Eastern Europe The transition countries of Central and Eastern Europe were the recipients of a massive influx of capital from abroad, mostly from Western Europe. Between 2003 and 2008 capital inflows reached very high levels – averaging more than 12 per cent of GDP – compared with an average for the emerging market countries overall of about 6 per cent (Figure 5). The transition countries were perceived as attractive investment opportunities: the lure of potential high returns, underpinned by relatively low wages and capital-output ratios, was reinforced by the prospect of faster income convergence entailed by economic and institutional developments in the context of EU membership and expectations of rapid interest rate convergence in connection with the eventual adoption of the euro. Financial integration in Central and Eastern Europe has been nearly unique. International banks played a fundamental role indeed in spurring financial integration. In the years running up to the global financial crisis, Western European banks expanded rapidly in the region, gaining substantial market shares through branches and subsidiaries; by 2008 they held as much as 80 per cent of total banking assets in these countries. The entry of foreign intermediaries with long-term strategic goals and the ensuing radical transformation of the ownership structure of banks in the CEE countries was a crucial element of discipline and stability in breaking the vicious circle of systemic crises and macroeconomic volatility that had marked the early years of transition. It is generally accepted that international financial integration has played a positive role in the long-term process of economic convergence in the CEE transition countries: long-term per capita GDP growth in the region before the crisis was positively correlated with conventional measures of financial integration, such as the ratio of gross foreign assets and liabilities to GDP (Figure 6). The evidence of this linkage in other emerging areas tends to be less clear-cut. The key extra contributing factor for the countries of Central and Eastern Europe may well be the interaction with institutional convergence implicit in the EU accession process. Thanks to this unique, favourable combination, presumably financial integration as such acted as a catalyst for the development of the domestic financial sector and the adoption of structural reforms to strengthen the institutional framework. However, a balanced account of the process of financial integration in this region must not overlook such drawbacks as excessive, cheap lending, currency mismatches and demand overheating in the years running up to the crisis. Between 2003 and 2008, many economies recorded rapid import growth, real-estate bubbles and wage increases far outpacing productivity gains – sometimes rooted in overly optimistic expectations of fast income convergence. Inflationary pressures spilled over into the tradeable sector and cut into export performance. Balance-of-payments deficits on current account widened (Figure 7). Several countries accumulated large external debts (Figure 8), largely private and denominated in foreign currency, making them vulnerable to a reversal of the capital flow or depreciation of the currency. When the global crisis began to impact on these countries, there was a sharp decline in capital inflows and a consequent slowdown in bank credit (Figure 9). See V. Rolli, “New policy challenges from financial integration and deepening in the emerging areas of Asia and Central and Eastern Europe”, Bank of Italy Occasional Paper Series No. 33, October 2008. BIS central bankers’ speeches Although there was concern over the possible meltdown of domestic financial systems driven by a rush of foreign banks to exit, a fully-fledged financial crisis along the lines of that in East Asia in 1997–98 did not materialize. Overall, during the first phase of the crisis, the reversal of capital flows was actually less severe than in other emerging areas. In some cases (Hungary, Latvia and Romania) substantial financial support from the EU and the main international financial institutions was crucial to avoiding the worst; coordination between home and host country authorities, international financial institutions and multinational banks, in the context of the Vienna Initiative, also helped prevent the sort of collective action problems that could have triggered the feared massive withdrawal of foreign banks.3 There is evidence that the foreign banks that participated in the Vienna Initiative were relatively stable lenders.4 Moreover, the distinctive model of financial integration in Central and Eastern Europe – where foreign banks operate mainly through local subsidiaries and branches in the retail market – evidently offered a high degree of risk-sharing and stability during the crisis, as parent banks tended to be less sensitive to information asymmetry and counterparty credit risk and more committed to long-term market prospects, given the important sunk costs of their in-country structures. This compares favourably with the dominant pattern in the other EU countries, where external borrowing by domestic banks is mainly in cross-border wholesale markets.5 The differing intensity of the boom-bust cycle in the various CEE countries suggests that apart from the influence of specific structural features (such as differences in starting income levels, international trade and financial links), domestic policy had a role, although capital inflows of the magnitudes observed in the region in the run-up to the crisis would certainly have strained any toolkit available to national policy makers. Monetary and exchange rate regimes probably played a critical role in determining each country’s ability to counteract the effects of capital inflows: the internal and external imbalances of the fixed- and floating-exchange-rate countries differed in size.6 The countries with fixed-exchange-rate regimes had sharper credit booms, higher inflation rates and larger current account deficits than the floating-rate countries, on average. Yet the contribution of the exchange rate regime remains an open issue; the question is whether the more extreme boom-bust cycle was driven mainly by the fixed exchange regime as such or rather by the inconsistency of the overall policy mix in countries where this setting was in place; in particular, a stricter fiscal stance and a better macroprudential policy framework might have at least partly compensated for the absence of exchange rate flexibility. As for monetary policy, the experience of the CEE countries appears to confirm that it is a less effective lever for restraining credit booms in small, financially open economies. This is the case even for floating-rate regimes, as a number of factors – currency substitution in the form of balance-sheet effects associated with initial high euroization, or the shift to foreign- The “Vienna Initiative” brought together systemically important cross-border banks, home and host country authorities, and international financial institutions to produce a coordinated response to the crisis. The banks pledged to their continuing commitment to the region, and in the case of five countries with IMF-supported programmes (Bosnia Herzegovina, Hungary, Latvia, Serbia, and Romania) the parent banks pledged to maintain their exposure. See R. De Haas et al., “Foreign banks and the Vienna Initiative: turning sinners into saints”, EBRD, Working Paper, No. 143, March 2012. See B. Cœuré, “International financial integration and fragmentation: Drivers and policy responses”, Conference organised by the Banco de España and the Reinventing Bretton Woods Committee, Madrid, 12 March 2013. In the period before the crisis, Bulgaria, Estonia, Latvia and Lithuania adopted hard pegs to the euro; Slovenia followed an intermediate crawling-band regime; the Czech Republic, Hungary, Poland, Romania, and the Slovak Republic were floaters. BIS central bankers’ speeches currency-denominated lending – could undermine or even reverse the intended effect of monetary tightening. This underscores the importance of maintaining a prudent fiscal stance during credit booms. Actually, in the years preceding the crisis headline fiscal positions in most CEE countries were broadly balanced, but in many cases this was the result of exceptional revenues associated with cyclical demand and asset price booms. Adjusted for these factors, the underlying fiscal positions looked much less healthy. With hindsight it is easy to recognize the need for a conservative approach in evaluating tax revenues during booms, and the useful role of automatic stabilizers (particularly income taxes and welfare spending) in increasing fiscal policy flexibility and attenuating economic fluctuations. In addition to the standard macro policy tools, CEE countries also took a wide range of prudential actions before the crisis. Prudential instruments can prevent or contain systemic financial risk in upswings (by affecting the incentives associated with asset price booms, foreign exchange lending, excessive risk-taking and the erosion of lending standards) and can also build buffers to cushion the impact of downturns. In general the evidence is that these measures produced the intended effects in the short run but sometimes failed to have a lasting impact on credit dynamics. In some instances, in fact, circumvention of the prudential intervention through direct cross-border financing and/or lending from unregulated, non-bank financial intermediaries proved to be a major issue; this was the case with direct limits on credit growth. A more effective role in containing systemic financial risks was played by measures specifically devised to build liquidity and loss-absorbing capital buffers, such as reserve and capital requirements. And when they were appropriately formulated, prudential regulations helped to curb the growth of foreign exchange loans and to keep default rates lower during the crisis. Lessons learnt from the global crisis: in search of better regulation Global financial deepening and international integration have resulted in greater risk sharing and made finance accessible to more countries, households and firms, thus proving instrumental in broadening economic development. But an interlinked and more closely connected financial system heightens the risks of contagion. Most importantly, the crisis has shown that market participants were not capable of mastering the inherent complexity of the system that they themselves had developed. And it has highlighted the shortcomings of the idea that self-regulation and market discipline are sufficient to ensure stable financial systems. In this regard, accepting the concept of benign neglect was a critical mistake on the part of regulators. Rather, financial regulation and supervision have to keep pace with developments in the financial industry. Moreover, national authorities need to be aware of the risk that their powers may become narrow compared to the sphere of influence of the global financial players. The coordination of financial supervision across countries and across sectors is a key condition for the stability of the global financial system.7 A major effort is required at the national but especially at the international level to strengthen the regulatory and supervisory framework. At the international level, under the political impulse of the G-20, the Financial Stability Board (FSB) and the Basel Committee on Banking Supervision have introduced substantial regulatory changes to prevent new financial crises and enhance the resilience of economic systems. Much has been already achieved. The quantity of capital that banks need to hold has been significantly increased and the quality enhanced, in order to ensure that they operate on a safe and sound basis. International standards for bank liquidity and funding have also been instituted to promote the resilience of banks to liquidity shocks. Initiatives have been taken to strengthen the For an analysis, see my lecture: “The Financial Sector After The Crisis”, Imperial Business Insights - Imperial College, London, 5 March 2013. BIS central bankers’ speeches regulation of the OTC derivatives market, aimed at reinforcing market infrastructures, in order to minimize contagion and spill-over effects among today’s more closely interconnected players. But further progress in important areas is needed, in that bank capital and liquidity regulation must be accompanied by improvements in internal risk control arrangements and actions aimed at correcting the incentives for excessive risk-taking. What is more, it is indispensable to level the playing field, since when a country relaxes the rules in order to attract financial intermediaries it generates negative externalities for other countries. The transition to a uniform system of rules and financial oversight must be hastened. In the euro area, and in the European Union at large, the plan for a banking union is ambitious, to be sure, but this is the direction in which to move. Among other things, it would limit regulatory arbitrage, help remove national bias in supervision, and reduce the phenomenon of “regulatory capture” by powerful cross-border banks, while at the same time reducing compliance costs for cross-border banks and enhancing the functioning of the single market for financial services. The planned European banking union would also benefit the economies of Central and Eastern Europe. It would work against the fragmentation of the European financial markets along national lines and – by enhancing the financial resilience of the euro area – it would reduce the risks of negative spill-over effects to the CEE banking systems. In conclusion The recovery of the CEE economies remains fragile. With few exceptions, output, held back by debt overhang and direct and indirect exposure to the eurozone debt crisis, has not yet regained pre-crisis levels. Import demand from the euro area remains at depressed levels. And although financial conditions have improved since the end of 2011 they remain volatile. Bank credit dynamics remain weak, reflecting subdued domestic demand and a large volume of non-performing loans. The banking systems of most of these countries remain well capitalized, however, and are consequently in a position to withstand the lingering deterioration of their asset quality. The financial legacy of the crisis will not be short-lived. The evolution of the international banking sector in the coming years will continue to shape financial conditions also in the CEE countries. The regulatory and supervisory responses adopted at global level will imply more stringent capital and liquidity requirements. In response to these more demanding rules, as well as to spontaneous market forces, international banks are adapting their business strategies, unwinding unsustainable pre-crisis practices and shifting to longer-term sources of funding. In this context the main European banks with large stakes in the CEE markets are gradually going over to more decentralized business models, in which subsidiaries will have to rely more heavily on local sources of funds and set their lending conditions accordingly. Orderly and even desirable for the resilience of the global financial system as this process may be, it could also put significant pressures on emerging countries that are highly dependent on external financing owing to underdeveloped domestic financial systems and structurally low national saving rates. Indeed, this calls for decisive reforms to bolster the development and deepening of local money and capital markets, including the issuance of bonds denominated in local currency. The process will be lengthy and complex, requiring a suitable legal framework, adequate infrastructures, a large institutional investor base, stable macroeconomic conditions and predictable policy-making, as has been demonstrated by the extensive analysis conducted and the guidelines then issued by the Bank of International Settlements (BIS), the World Bank and the G20.8 Several of these conditions have already been achieved in the process of integration in the EU. See: BIS Committee on the Global Financial System: “Financial stability and local currency bond markets”, CGFS Papers, No. 28, June 2007. See also the “G20 Action Plan to Support the Development of Local Currency Bond Markets”, November 3–4, 2011. BIS central bankers’ speeches Against the backdrop of this changing financial environment, one risk is that, arguing the need to preserve domestic financial stability, national regulators could adopt ring-fencing measures, hampering the smooth functioning of the EU single market. As the long-term benefits of free capital mobility and international financial integration remain substantial, averting this risk requires that the EU institutions, notably the European Commission and the European Banking Authority, play a greater role in monitoring these measures and enhancing coordination among national regulators, in order to avoid the fragmentation of the European financial markets. BIS central bankers’ speeches Fig. 1 Size of capital markets (ratios to GDP) Bank credit to the private sector 3,5 Domestic debt securities issued by the private sector United States Euro area Stock market capitalisation Japan United Kingdom 3,0 2,5 2,0 1,5 1,0 0,5 0,0 Sources: IMF International Financial Statistics, BIS, Datastream. Fig. 2 Notional value of over-the-counter and exchange-traded derivatives (outstanding amounts in billions of US dollars; end of year data) 800.000 Exchange-traded OTC 600.000 Total 400.000 200.000 Source : BIS Quarterly Review, March 2013. (1) OTC derivatives include credit default swaps. (2) Data as of June for 2012 . BIS central bankers’ speeches Fig. 3 Gross stocks of foreign financial assets and liabilities in percent of GDP (sum of financial assets and liabilities in per cent of GDP) Industrial countries Emerging countries 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Source: our calculations based on Lane and Milesi-Ferretti database. (1) For each group, weighted average calculated using GDP weights. Fig. 4 Size of capital markets in selected emerging regions (ratios to GDP) Bank credit to the private sector Domestic debt securities issued by the private sector Stock market capitalization 3.0 CEE countries (1) Emerging Asia (1) 2.5 2.0 1.5 1.0 0.5 0.0 Sources: our calculations based on data from BIS, IMF, national statistics and Datastream. (1) For each group, weighted average calculated using PPP shares of world GDP; (2) Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia and Slovenia; (3) China, Hong Kong, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan and Thailand. BIS central bankers’ speeches Fig. 5 CEECs: International capital inflows (2003-2008 average) (as a percentage of GDP) FDI Portfolio Investment Other Investment -5 Bulgaria Czech Republic Estonia Hungary Latvia Lithuania Poland Romania Slovak Republic Slovenia CEE_10 All emerging countries Source: Our calculations on data from IMF WEO database and national statistics. For groups, weighted average calculated using GDP weights. Fig. 6 CEECs: changes in international assets and liabilities versus real per capita GDP growth Estonia Changes in international assets and liabilities (1998/2007; percentage points of GDP) Slovenia Latvia Bulgaria Lithuania Hungary Romania Slovak Republic Poland Czech Republic Real per capita GDP growth (1999-2008 average; annual percentage changes) Source: Our calculations based on Eurostat and Lane and Miles-Ferretti database. BIS central bankers’ speeches Fig. 7 CEECs: net international capital inflows (2003-2008 average) (as a percentage of GDP) Current account balance Net Capital Inflows Reserve assets -5 -10 -15 -20 Bulgaria Czech Republic Estonia Hungary Latvia Lithuania Poland Romania Slovak Republic Slovenia Romania Slovak Republic Slovenia Source: Our calculations based on data from IMF WEO database. (1) Inflows - Outflows (excluding reserve assets). (2) A minus sign indicates reserve accumulation. Fig. 8 CEECs: Gross External Debt (year-end stocks, as a percentage of GDP ) Czech Republic Estonia Bulgaria Hungary Latvia Lithuania Poland Source: Our calculations based on IMF WEO and Wold Bank database. BIS central bankers’ speeches Fig. 9 CEECs: changes in selected variables before and after the last global crisis (2009-12 versus 2003-08 periods; as a percentage of GDP) Current Account GDP Capital Inflows - right scale Domestic credit - right scale -5 -17 -10 -33 -15 Bulgaria Czech Republic Estonia Hungary Latvia Lithuania Poland Romania Slovak Republic Slovenia Source: Our calculations based on IMF WEO and International Financial statistics database. (1) Changes in average balances. - (2) Changes in average annual growth rates. - (3) Changes in average annual flows. BIS central bankers’ speeches -50 | bank of italy | 2,013 | 5 |
Remarks by Mr Fabio Panetta, Deputy Director General of the Bank of Italy, during the presentation of the 2013 Financial Stability Review, Central Bank of Luxembourg, Luxembourg, 14 May 2013. | Fabio Panetta: Macroprudential tools – where do we stand? Remarks by Mr Fabio Panetta, Deputy Director General of the Bank of Italy, during the presentation of the 2013 Financial Stability Review, Central Bank of Luxembourg, Luxembourg, 14 May 2013. * 1. * * Introduction I would like to thank the Banque Centrale du Luxembourg (BCL) for inviting me to this conference. It is a pleasure to be here, and to discuss the challenges associated with the implementation of macroprudential (MAP) policy. It is a very topical subject. The unusually expansionary stance of monetary policy in the major regions is putting pressure on asset prices and, in a context of weak economic activity and low inflation, may soon require appropriate macroprudential measures. It is essential, therefore, to deepen our understanding of MAP policy implementation and the optimal choice of MAP tools. The debate on MAP policy that is taking place in academic and policy circles has produced consensus on a few issues. First, macroprudential policy should aim to contain systemic risk. However, this is by no means a univocal statement of objectives, as systemic risk has multiple facets, and defies clear measurement. Even the usual distinction between the cross-sectional dimension and the time-series dimension of systemic risk,1 although conceptually important, does not provide an operational definition of the objective of MAP policy. Second, MAP policies have important interactions with other policies, such as monetary and fiscal policy, and microprudential policy. Yet, these interactions are largely unexplored. Third, selected MAP instruments seem to have some effectiveness. However, the experience gathered thus far on the use of these instruments is still limited, and refers largely to developing economies. This brief discussion suggests that in spite of the progress made, our understanding of MAP tools and their impact on the financial system and the real economy remains very incomplete. Several important questions await an answer. For example, when imbalances emerge, should we prefer broad-based or narrow instruments? How to monitor and minimize elusion? What definition of the various instruments (e.g. the LTV) should be used? Do MAP authorities have the statistical information or the legal basis to implement MAP policies? The European Systemic Risk Board (ESRB) recently found that, as of September 2012, only two countries were fully compliant with its recommendation on the macroprudential mandate of national authorities, suggesting that the answers to the previous questions are at best unclear. Moreover, a survey on euro-area countries recently conducted by the Bank of Italy indicates a surprisingly poor state of affairs concerning statistics on residential LTVs: information is often of poor quality or even missing altogether. Definitions are barely harmonized across countries. Clearly, substantial progress is still necessary in this field. Given our limited experience, we must rely on a learning-by-doing approach: start experimenting with MAP tools and observe the consequences, focusing on (not-so-glamorous) technical details. My comments today are devoted to operational issues. I will focus on three aspects in particular. First, I shall briefly look at recent experience with MAP tools (Section 2). I will The cross-sectional dimension of systemic risk refers to the interconnectedness and common exposures in the financial system, while the time-series dimension refers to the pro-cyclicality of the financial system. See, for example, Bank of England (2009), “The Role of Macroprudential Policy”, Discussion Paper, November; C. Borio (2010), Implementing a macroprudential framework: Blending boldness and realism, BIS; J. Caruana (2010), Systemic risk: how to deal with it?, BIS, February. BIS central bankers’ speeches then review some conceptual issues on the implementation of MAP tools (Section 3). In Section 4 I will focus on operational challenges in the euro area. Conclusions are drawn in Section 5. 2. Previous experience with macroprudential tools Most of the previous experience in practical implementation of MAP policies relates to emerging/non-G10 economies, such as South Korea, Brazil, Turkey, and several others.2 By contrast, experience in developed economies is very limited. Exceptions are Spain, where dynamic provisioning has been applied since 2000; Switzerland, which recently introduced countercyclical capital requirements; New Zealand, which has autonomously applied a structural liquidity measure similar to the Basel III Net Stable Funding Ratio; and the UK, where a fully-fledged operational framework for MAP policy has been set up and the authorities are ready to start experimenting with countercyclical and sector-specific capital requirements. Many other countries are likely to enter this uncharted territory, partly in connection with the implementation of Basel III. The non-advanced economies’ lead in applying MAP policies is probably due to two main reasons. First, these economies started pioneering MAP tools following the systemic crises and severe financial instability episodes experienced since the 1990s. By contrast, most developed countries started considering MAP tools only after the Global Financial Crisis and in most cases have not yet used them in practice. With the benefit of hindsight, we now know that the cushions accumulated in the run-up to the crisis (capital buffers, liquidity reserves) were too small, so that when the crisis erupted there was little that policymakers could do in the way of releasing instruments in a countercyclical fashion. In other words, in many countries MAP policies were “at their lower bound”, leaving little room for policy action.3 Second, the distinction between MAP measures and unsophisticated monetary policy measures is often not clear-cut. At least some policies and tools that are labelled “macroprudential” in emerging economies were de facto substituting for insufficiently developed monetary policy frameworks. This, for example, is the case of reserve requirements and quantitative limits on credit.4 Hence, the available empirical evidence from emerging economies about MAP policy effectiveness may have to be interpreted with caution. This caveat notwithstanding, the available empirical evidence suggests that MAP tools do have some effectiveness.5 Moreover, recent research conducted at the Bank of Italy These countries experienced both time-varying and structural measures. For example, the Brazilian authorities have experimented with capital requirements on new loans to households and reserve requirements; Turkey with foreign- exchange intervention and policy-induced volatility on short-term rates (to counteract large capital inflows), reserve requirements, LTV limits, and increases in risk-weights and general provisions on new consumer loans. Korea has implemented LTV and DTI limits on mortgage lending, levies on non-core foreign exchange liabilities and ceilings on banks’ foreign exchange derivatives positions. Hong Kong has also used LTV and debt servicing ratios and haircuts on share margin financing and repo transactions. P. Angelini, S. Nicoletti-Altimari and I. Visco (2013), “Macroprudential, microprudential and monetary policies: conflicts, complementarities and trade-offs”, in Stability of the Financial System – Illusion or Feasible Concept?, edited by A. Dombret and O. Lucius, Edward Elgar, and Bank of Italy, Occasional Papers, 140, November (2012). For example, in Italy, administrative controls on loans were used to steer monetary policy in the 1970s, when there was no liquid money market. Reserve requirements were used to absorb excessive monetary base. Among others, see G. Dell’Ariccia, D. Igan, and L. Laeven (2008), “Credit Booms and Lending Standards: Evidence from the Subprime Mortgage Market”, CEPR Discussion Papers 6683; G. Dell’Ariccia, D. Igan, L. Laeven, and H. Tong with B. Bakker and J. Vandenbussche (2012), “Policies for Macroprudential Stability: How to Deal with Credit Booms”, IMF Staff Discussion Note 12/6; C.H. Lim, F. Columba, A. Costa, P. Kongsamut, A. Otani, M. Saiyid, T. Wezel, and X. Wu (2011), “Macroprudential Policy: What Instruments BIS central bankers’ speeches and elsewhere, also using theoretical calibrated or estimated models, finds that cooperation between monetary and macroprudential policies in targeting financial imbalances may lead to significant gains.6 All in all, in developed and emerging economies alike, there seems to be a lot to learn in this field: about the true degree of independence of MAP tools from other policies; about the independence of the various MAP tools from each other. And about some important conceptual and practical issues that deserve attention to make MAP instruments fully operational, an issue to which I turn in the next two sections. 3. Conceptual issues on the use of macroprudential tools Lists of potential MAP tools have been drawn up by many authorities.7 The ESRB has put up for internal use a list so exhaustive as to earn the label “the yellow pages”. But nowhere more than in this field is actual progress likely to come from a learn-by-doing approach. Therefore, in this section I will focus on some of the issues that might challenge the effective implementation of MAP policy, such as 1) the scope of application of MAP tools and the risk of policy circumvention and leakages; 2) the possibility of symmetric (versus asymmetric) impact of the MAP measures; and 3) the speed at which policy tools can be adjusted. Finally, in Section 4 I shall discuss a number of operational challenges in Europe. 3.1 Scope of application of MAP tools: broad or targeted? Circumvention and leakages Broad versus targeted instruments. A first issue relates to the scope of application of MAP tools. Some instruments are system-wide, and therefore well-suited to lean against the build- up of imbalances or risks in the entire financial system. For instance, during a generalized credit bubble system-wide countercyclical capital buffers, or liquidity and reserve requirements, are likely to be effective in curbing the build-up of risks and endowing the system with loss absorption capacity. However, they can be blunt tools to counter a sector- specific overheating. In this case, the tightening required for a systemwide tool to work would be unrealistically high, not cost-effective and rife with side-effects. Targeted instruments may be more suitable for dealing with risks arising in particular segments or subsectors of the financial system (examples are sector-specific capital requirements, LTVs, and limits on foreign exposures).8 However, targeted measures tend and How to Use Them? Lessons from Country Experiences”, IMF Working Papers 11/238; G. Terrier, R.O. Valdés, C.E. Tovar, J.A. Chan- Lau, C. Fernández-Valdovinos, M. García-Escribano, C. Medeiros, M. Tang, M. Vera Martin, and C.W. Walker (2011), “Policy Instruments to Lean Against the Wind in Latin America”, IMF Working Papers 11/159. P. Angelini, S. Neri, and F. Panetta (2011), “Monetary and Macroprudential Policies”, Bank of Italy Working Paper 801; Angelini, Nicoletti-Altimari and Visco, (2013), op. cit.; L. Gambacorta and F.M. Signoretti (2013), “Should Monetary Policy Lean against the Wind? An analysis based on a DSGE model with banking”, Bank of Italy, Working Paper, forthcoming; S. Claessens, K. Habermeier, E. Nier, H. Kang, T. Mancini-Griffoli, and F. Valencia (2013), “The Interaction of Monetary and Macroprudential Policies”, IMF Policy Paper; O. Blanchard, G. Dell’Ariccia and P. Mauro (2013), “Rethinking Macro Policy II: Getting Granular”, IMF Staff Discussion Note, 13/03. The set of core instruments includes the countercyclical bank capital buffer, envisioned in the Basel III regulation; changes in sectoral risk weights, a tool recently assigned to the UK Financial policy committee; limits on loan-to- value, on debt-to-income ratios; and so on. The scope of the instruments can be very narrow, to the point that one may question whether they are really macroprudential in nature. For example, in Korea LTV limits were envisaged for mortgages in specific areas of Seoul, where real-estate conditions were considered speculative. See D. Igan and H. Kang (2011), “Do Loan-to-Value and Debt-to-Income Limits Work? Evidence from Korea”, IMF Working Paper 11/297. BIS central bankers’ speeches to be more prone to two related problems: circumvention/elusion and leakages/waterbed effects. Circumvention/elusion occurs when the agents to which the policy measure is directed find ways to mitigate or even neutralize it. Leakages/waterbed effects arise when the agents to which the measure is directed are fully affected, but other sectors are also affected and adjust their behaviour so as to contain the impact of the measures. Due to these effects, MAP policy can at best lose effectiveness; at worst, it can exacerbate imbalances in parts of the system. Circumvention/elusion. Macroprudential tools and policies are prone to circumvention, but this is also true of most regulation. Is there anything that makes MAP tools different? Two remarks are in order. First, the problem of circumvention tends to be more acute when MAP measures are targeted. A few examples may help to clarify this claim. First, consider the case of LTV limits on mortgages. Faced with these limits, banks may use alternative products, such as personal loans, to expand their real-estate exposure beyond the established limits, reducing the measure’s effectiveness. Similarly, intermediaries may circumvent sector-specific capital requirements by extending personal loans to entrepreneurs rather than to their firms, hence avoiding additional capital absorption. By the same token, borrowers may elude limits on the debt-to-income (DTI) ratio by tapping multiple lenders, who have no way of controlling circumvention unless a central credit register is in place. Even where such an infrastructure exists, the borrower would still be able to elude the limit by having other household members apply for the loan. Finally, consider also the case of instruments targeted to maturity mismatches, such as the limit on long-term foreign currency lending established in South Korea in the 1990s: at least 70 per cent of foreign-currency loans with maturity above 3 years had to be matched by foreign currency liabilities with the same maturity threshold. As Korean banks had little if any access to long-term foreign currency funding, they entered funding contracts with maturity of 3 or more years but with early reimbursement clauses, so that in practice the maturity was much shorter (1 year or so).9 This allowed them to borrow at relatively cheap rates, formally complying with the regulation but de facto eluding it. My second remark is that elusion is more likely to occur during cyclical upturns. Consider again one of the above examples: lenders know well that the credit risk of lending to an entrepreneur is the same as that of lending to his/her firm. When optimism prevails and risk aversion is low, they will be more willing to overlook prudency. Indeed, elusion requires lenders and borrowers to collude, and this tends to be more likely in the positive phase of the business cycle, exactly when the tightening measures should be taken. As I shall argue below, this may have consequences for the effectiveness of MAP policies over the cycle. Leakages/waterbed effects. A related problem is the risk of leakages (or waterbed effects), which occur when MAP policy measures propel imbalances elsewhere in the system. This is also a special case of the tendency of regulation to push activity towards the less regulated part of the financial system (such as the shadow banking system). But the effect may also arise within the regulated financial system. For example, in the UK, between 1998 and 2007, the resident branches of foreign banks – which unlike subsidiaries, are not subject to host country regulation – increased lending in response to tighter capital requirements on domestic regulated banks, thereby offsetting about one third of the tightening manoeuvre.10 The reciprocity arrangements included in the Basel III package J. Kyu Lee (2013), “The Operation of Macroprudential Policy Measures: The Case of Korea in the 2000s”, Bank of Korea Working Paper, 2013–1. S. Aiyar, C.W. Calomiris, and T. Wieladek (2012), “Does macropru leak? Evidence from a UK policy experiment”, Bank of England Working Paper No. 445. BIS central bankers’ speeches and the CRD-IV/CRR package address the waterbed effect for the Countercyclical Capital Buffer, although other tools remain uncovered by formal reciprocity provisions. What are the solutions? What, if any, are the solutions to circumvention and waterbed effect? There clearly is no silver bullet, but policies can help to mitigate problems. First, effective micro supervision can go a long way towards addressing circumvention. In particular, a system that relies heavily on on-site inspections would create a strong deterrent against elusive behaviour. Refer to one of the above examples, in which a bank uses personal loans to elude sector-specific capital requirements or LTV limits: on-site inspections would very likely uncover this behaviour. Effective supervision would also alert the authorities to waterbed effects, allowing them to take swift corrective action. While effective supervision and extensive on-site inspections are costly, for both the supervisor and the intermediaries, the crisis has demonstrated that the cost of inadequate supervision can be huge. To the extent that elusion requires collusion between lenders and borrowers, onsite supervision should be intense also during positive phases of the business or financial cycle. Second, in response to elusion and waterbed effects, authorities may broaden the scope of their policies, e.g. with the simultaneous use of complementary macroprudential tools, rather than a single targeted tool. The possibility to circumvent an LTV limit could be substantially reduced if it were used together with a DTI limit consolidated at borrower level. In fact, while the former would limit the loan exposure relative to the collateral value, the latter would constrain the level of overall lending to each given customer based on his/her income. A similar argument can also be made for the sector-specific capital requirements and DTI.11 Third, authorities can extend the perimeter of regulation dynamically in order to include segments of the system that have become systemically relevant (UK legislation has granted this power to the FPC).12 In this respect, the comprehensive approach adopted in Italy – where all financial intermediaries are subject to supervision, with appropriate proportionality – has some merits.13 Finally, it should be clear from the above examples that effective cross-border cooperation among authorities is another important method of fighting spillovers. My assessment is that at present, unfortunately, centrifugal forces seem to prevail, in Europe as elsewhere. 3.2 Is the functioning of macroprudential tools symmetric or asymmetric? Another issue to address in order to make MAP tools operational relates to their symmetric or asymmetric effectiveness along the financial cycle. The premise is that MAP measures are effective if and only if they impose – or remove – economically binding limits, that is, if they are more stringent than the constraints imposed on intermediaries by voluntary decisions or by market pressures. For example, if during recessions risk aversion or market pressures raise banks’ desired capital ratios above regulatory thresholds (a situation that applies to many economies in the current environment), a policy of releasing capital constraints (e.g. via the countercyclical buffer) would have no effect:14 the authority would find itself pushing on a string. This reasoning suggests two considerations. As pointed out by Blanchard et. al. (2013), op. cit. Bank of England (2013), The Financial Policy Committee’s powers to supplement capital requirements, A Draft Policy Statement, January. Under this approach, regulatory and supervisory actions are proportional to the intermediary’s importance. D. Diamond and R.G. Rajan (2009), “The Credit Crisis: Conjectures about Causes and Remedies”, NBER Working Paper No. 14379; R.G. Rajan (2005), “Has Financial Development Made the World Riskier?”, NBER Working Paper No. 11728. BIS central bankers’ speeches First, MAP tools should in principle be more effective during upswings of the financial cycle: when optimism prevails, market constraints are weaker and banks typically hold less excess capital or liquid buffers. However, as already mentioned, during such times incentives towards elusion are likely to be stronger. These two offsetting effects make it hard to gauge whether MAP instruments are more effective during upturns than downturns. Second, for an effective release of some MAP tools in bad times, there must have been an adequate tightening in good times. This is vividly illustrated by the behavior of capital ratios during the current crisis. Large banks, typically endowed with thin capital buffers, reacted to the downturn by increasing capital procyclically. By contrast, small banks, which entered the crisis with large capital buffers, effectively acted as stabilizers. There is clear evidence of this behaviour for both the US and the European banking systems (see Figure 1).15 The IMF has recently analysed the degree of symmetry of MAP policies, without reaching firm conclusions. In the 36 countries examined, between 2000 and 2011 the cases of policy tightening far outnumbered the episodes of loosening. Most of the loosening measures, often consisting in the relaxation of previously tightened instruments, occurred after 2008. The econometric exercise is inconclusive on whether MAP measures have symmetric or asymmetric effects, but the results have to be interpreted with caution, as the incidence of loosening events may be too small to detect statistically significant differences.16 3.3 Adjustment of policy tools: speed, size The speed at which policy tools can be adjusted also deserves attention. In the Netherlands, a recent decision by the government (contained in the 2012 Stability Programme) forsees a gradual lowering of the maximum LTV ratio from 106 per cent in 2012 to 100 per cent. The decline is expected to take place at a pace of about 1 percentage point per year. As a comparison, in Italy the average LTV declined by almost 10 percentage points from 2006 to 2012 – about 1.6 percentage points per year. This is a much faster adjustment – note that it was not driven by the regulator, but by banks’ autonomously adopted policies. What is the right adjustment speed? A look at housing market cycles provides insights in this respect. Both upturns and downturns in housing cycles in advanced countries last on average around 5 years.17 This suggests that the tightening pace adopted in the Netherlands might be too slow, with risks that the countercyclical policy could be fully effective only at the turning point of the cycle. This is not a criticism;18 I just mean to illustrate a general point. My assessment is that our knowledge in this area is particularly poor, and that we must make the most of the empirical evidence that will accumulate from future policy experiments. The speed of adjustment is clearly related to the size of the adjustment. For example, the countercyclical capital buffer will have to be managed taking into account that an increase, say, will affect all banks at the same time. Therefore, a sudden, sharp increase could S.G. Hanson, A.K. Kashyap, and J.C. Stein (2011), “A Macroprudential Approach to Financial Regulation”, Journal of Economic Perspectives, 25(1): 3–28 and Angelini, Nicoletti-Altimari and Visco (2013), op. cit.. E. Nier, H. Kang, T. Mancini-Griffoli, H. Hesse, F. Columba, R. Tchaidze, and J. Vandenbussche (2012), “The Interaction of Monetary and Macroprudential Policies – Background Paper”, IMF Policy Paper. The analysis suggests that the effect on credit growth of changing the reserve requirement is stronger when loosening than when tightening. On the other hand, the effect on house prices of changing LTV ratios is stronger for tightening than for loosening. For the other macroprudential tools considered there is no significant difference. S. Claessens, A. Kose, M. Terrones (2011), “Financial Cycles: What? How? When?”, IMF Working Papers, 11/76. The policy move in the Netherlands may be structural in nature, since LTVs exceeding 100 per cent are probably questionable apart from cyclical considerations. BIS central bankers’ speeches send many banks scrambling for funds at the same time, generating a system-wide dearth of capital. Of course, this makes this tool potentially very powerful. 4. Operational challenges in Europe Let me now turn to two practical aspects in the implementation of macroprudential tools on which significant progress is required, with a focus on Europe. 4.1 Gaps in the statistical framework One not very glamorous but key issue is the question whether statistical reporting is adequate to help ensure policy implementation and instrument effectiveness. Consider the housing market. Housing market cycles differ substantially across countries (Figure 2), suggesting that MAP policies aimed at curbing problems of overheating in the realestate sector should be tailored to the national situation. The regulation being finalized in the EU (CRD-IV/CRR) properly allows for national leeway. In line with this evidence, a recent survey among euro-area NCBs, conducted by the Bank of Italy and presented in our latest Financial Stability Report, shows that there is substantial dispersion of average LTV ratios in the euro area.19 Ratios on new loans in 2011 ranged from below 60 per cent in some countries to more than 100 per cent in others (Figure 3; one must bear in mind that LTV is not yet a MAP instrument in most EU countries). There is also significant heterogeneity in the underlying statistics. For example, the survey just mentioned showed differences with regard to the LTV definitions and the methods of collecting and aggregating data across Europe. Should the value of the real estate be recorded at mortgage issuance? Or, should it be updated? If so, how? Should there be a difference between first homes and other houses? The list could continue. Each different answer to any of these questions may give rise to methodological differences in computed LTVs. These discrepancies hamper cross-country comparisons; going forward, they can hinder MAP implementation and coordination among the euro-area countries. Work to harmonize statistics in this field is beginning in the light of the forthcoming establishment of the Single Supervisory Mechanism (SSM). Consider next non-performing loans (NPLs). These are arguably key pieces of information for micro as well as for macroprudential policies. But lack of a harmonized definition, even at the European level, prevents robust cross-country comparisons. As an example, the definition used by Italian banks – which is set by the Bank of Italy – is generally broader and more rigorous than elsewhere in Europe.20 Our analyses show that, controlling for differences in the way collateralized positions are treated in the definition of NPLs, Italian banks would display on average substantially better NPL and coverage ratios (Figure 4). Also, the dynamics of the two ratios would change substantially: whereas the official coverage ratio decreased by 1.5 percentage points between 2009 and 2012, the “adjusted” ratio (computed according to the methodology used by a sample of large European banks) would increase by 3.3 points. What is more, this is just one of the factors affecting cross-country comparison of NPLs. Other differences emerge, e.g. with respect to the definition of restructured loans. A cross-country comparison that fails to take these methodological problems properly into account would be misleading. The issue is clearly thorny, because changing well-established national practices to converge to a uniform standard entails Bank of Italy (2013), Financial Stability Report, No. 5, April. (http://www.bancaditalia.it/pubblicazioni/stabilitafinanziaria/rapporto-stabilita-finanziaria/2013/rsf_2013_5/en_stabfin_5_2013/Financial-Stability-Report-5.pdf). See S. Barisitz (2013), “Nonperforming Loans in Western Europe – A Selective Comparison of Countries and National Definitions”, in Oesterreichische Nationalbank, Focus on European Economic Integration, Q1/13 (http://www.oenb.at/de/img/feei_2013_q1_studies_barisitz_tcm14-253775.pdf). The study suggests that, in international comparisons, NPL ratios for Italian banks are biased upwards. BIS central bankers’ speeches adjustment costs, which generate resistance. The asset quality review that planned under the developing SSM should address these problems. A last example concerns indicators of banks’ funding/liquidity conditions. For lack of data, the funding gap is often approximated by the loans-to-deposits ratio (this was standard practice in the IMF GFSR until recently, and it still is in the FSR of the European Central Bank). However, correct measurement of the gap should consider all sources of retail funding, including bank bonds subscribed by retail customers (which proved to be as stable as retail deposits). Given large cross-country differences (for example, retail bonds are an important source of funding in Italy, but not in other countries), the use of rough measures, sometimes induced by lack of publicly available data, may misrepresent the true funding conditions of banks in some countries and alter international comparisons (Figure 5).21 4.2 The institutional framework in Europe A full assessment of the institutional set-up for MAP policy in the European Union is premature, also in the light of the implementation uncertainties for the SSM. However, it is clear that the various reforms and regulations introduced have produced a very complex framework. An effort is necessary to minimize inefficiencies and foster an effective interaction among the different actors involved. Several key issues remain to be addressed. The first has to do with the respective roles and powers of the SSM and the National MAP Authorities (NAs). The legislation being finalized (CRD-IV/CRR and the SSM Regulation) gives asymmetric powers to the two parties, with the ECB able only to tighten macroprudential tools above the regulatory minima and the NAs empowered to implement bidirectional policies. At the same time, however, a symmetric feature is also envisaged by the rules: the ECB can object to policy decisions taken by the NAs, which will in turn have to “duly consider” any such objections; the NAs can do the same with regard to ECB’s decisions, and the ECB has also to “duly consider” the NAs’ objections. As for this symmetry of “objection” powers, it remains to be seen who will have the final say if the objections are not duly taken into account. Without a tie-breaking mechanism, the risk of a stalemate seems by no means negligible. A related issue is that of cooperation/coordination between the SSM and the NAs. This is explicitly addressed only for the tools included in the CRD-IV/CRR package. It is essential that work continue on the definition of a coordination framework also for instruments currently excluded from the European regulation, such as the LTV or the DTI ratios, as an equilibrium relying mainly on authorities’ good will could turn out to be unstable. Such a framework would help address the risk that measures taken with a purely domestic perspective have negative spillovers on other countries. A final issue concerns the interaction between the ESRB and the SSM, which is also likely to be complex. Should the ESRB be strengthened and made more independent from the ECBSSM? Or should it be kept as a lean institution, in charge of coordination among SSM countries and other EU countries, and among central banks and supervisory authorities not represented in the SSM? The debate is in its early stages. Much will depend on how many EU countries join the SSM. While each solution has its pros and cons, the risk of an overcrowded arena in the MAP field is material. In the October 2012 GFSR the IMF calculated a 176 per cent loan-to-deposit ratio for Italian banks. For the same date, a figure of 117 per cent can be derived once retail bonds are taken into account (see Bank of Italy (2012), Financial stability report, No. 4, November). In the GFSR published last April, following discussions with the Bank of Italy, the IMF itself included the correct definition of retail liabilities in their analysis. BIS central bankers’ speeches To maximize the effectiveness of the MAP framework in Europe, a principle that should be heeded is that strong microprudential supervision is a necessary precondition for effective macroprudential policy. Indeed, MAP policy is to a large extent the use of microprudential tools with a macro perspective. It is therefore crucial to coordinate the use of prudential tools for both purposes. As an example, consider the actions that the Bank of Italy recently undertook with the aim of increasing bank provisioning, in order to improve investor confidence in Italian banks. With a macroprudential perspective, in order to avoid procyclicality the Bank of Italy at the same time asked banks to increase internallygenerated resources by containing costs, disposing of non-strategic assets and aligning dividend policies to their balance-sheet and income strength. These actions should limit the risk that, in a context of weak economic activity and tight credit conditions, the increase in provisioning might lead to a deterioration in the availability of credit to the private sector. 5. Conclusions Macroprudential policy may play a crucial role in preserving financial stability. But in this new field of policymaking, more than in others, we should keep in mind that no solution is obviously right or wrong. More experience is needed on the functioning of macroprudential authorities and the use of tools. As progress will inevitably follow from a learn-by-doing type of approach, policymakers should not shy away from carefully planned but bold experiments. Some countries are already moving in this direction. The signs of overheating that are emerging in some segments of the financial system may soon require appropriate macroprudential measures. Policymakers should not repeat the errors made in the run-up to the crisis, when many supervisors turned a blind eye to the imbalances that were building up in their economies. Some conceptual steps need to be taken. First, elusion and waterbed effects may hamper the effectiveness of MAP policies, especially when measures are narrow. A system of tight micro supervision can go a long way towards addressing circumvention. The simultaneous use of complementary macroprudential tools, rather than a single targeted tool, can also help. Effective cross-border cooperation is key to fight spillovers. Unfortunately, at present centrifugal forces seem to prevail, in Europe as elsewhere. Second, we need to explore carefully the degree of asymmetry of MAP tools over the financial cycle. In principle, MAP tools should be more effective during upswings, whereas during downturns market pressures may impose excessive constraints on intermediaries, making the policies of releasing the previously accumulated buffers less effective. In practice, however, during upswings incentives towards elusion are likely to be stronger. These two offsetting effects make it hard to establish whether MAP instruments are more effective during upturns than downturns. Also, for an effective release of some macroprudential tools in bad times, there must have been a substantial tightening in good times. The speed at which policy tools can be adjusted also deserves attention. Third, a prerequisite to make progress in all of the above areas is to have a reliable statistical framework. The amount of work needed to harmonize key indicators for MAP policy is immense, even within the EU. Finally, progress is needed in the definition of the institutional and legal framework for MAP policy. At the global level, the design of financial regulation involves, in different degrees, several authorities and supranational bodies (the G20, the FSB, the IMF, the BIS, to name just the main ones). The macroprudential arena is also very crowded. In Europe, tasks are today (or will be shortly) shared among the ESRB, the ECB, the European Commission, and the NAs. There is a material risk that such a proliferation of fora and decision-making bodies could end up complicating coordination and synergies. In this context, I believe that serious thought should be given to institutional simplification and a clear allocation of tasks. BIS central bankers’ speeches Figure 1 Tier 1 risk-based capital ratios for commercial banks, by bank size (percentage points) a) USA b) Europe c) Italy Source: Panel (a): Hanson, Kashyap and Stein (2011); panel (b): ECB; panel (c): Angelini, Nicoletti-Altimari and Visco (2013), op. cit. BIS central bankers’ speeches Figure 2 House prices in Europe (current prices; indices, 2000=100) Figure 3 Loan-to-value ratio in selected euro area countries (per cent) BIS central bankers’ speeches Figure 4 Effect of collateral and guarantees on the Italian banking system’s NPL and coverage ratios (per cent) BIS central bankers’ speeches Figure 5 Loan-to-deposit ratio in selected countries (per cent) BIS central bankers’ speeches | bank of italy | 2,013 | 5 |
Concluding remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Ordinary Meeting of Shareholders 2012 - 119th Financial Year, Bank of Italy, Rome, 31 May 2013. | Ignazio Visco: Overview of economic and financial developments in Italy Concluding remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Ordinary Meeting of Shareholders 2012 – 119th Financial Year, Bank of Italy, Rome, 31 May 2013. * * * Ladies and Gentlemen, In these remarks I will give an account of a difficult year and speak about the severe test that we have all had to face. I will recall you of what has been done, describing the role of the Bank of Italy. I will speak about the progress made, even if it is insufficient; about the results achieved, although these are still fragile; about the need not to waste but to defend and consolidate these achievements in order to set the recovery process in motion; and lastly about the conditions for a return to balanced growth. Allow me to start with a farewell, in fact with more than one. On 28 April, in this delicate moment in the life of the country, our Director General Fabrizio Saccomanni was called to join the Government as Minister for the Economy and Finance. Endowed with outstanding personal and professional qualities, he has worked in almost all of the Bank’s institutional and administrative fields of action. His experience, his thorough knowledge of the European and international organizations in which he has held prominent positions and performed important tasks for Italy, the competence and balance he has demonstrated in his many years of service to the Bank, for which we owe him a debt of gratitude, will be even more essential in the test that awaits him. We extend our warm best wishes to him. He is succeeded by Salvatore Rossi, our former Deputy Director General, who has for many years combined broad managerial responsibilities with economic analysis attentive in particular to innovation and development. As Director General, he is also Chairman of the Insurance Supervisory Authority, which at the beginning of the year was placed by law under the direction of the Governing Board of the Bank of Italy, assisted by two outside directors. In July 2012 Anna Maria Tarantola, the first woman on our Governing Board, left the Bank to become president of the state broadcasting corporation RAI, a challenging assignment that recognizes her management skills and professional rigour. In December, at the end of a career that was exemplary for commitment, dedication and analytical and institutional contributions, Deputy Director General Giovanni Carosio concluded his mandate. I would like to thank both of them warmly for their contribution of ideas and activity on behalf of the Bank. Between October 2012 and 10 May the Governing Board was brought back up to strength with the appointment of Deputy Directors General Fabio Panetta, Luigi Federico Signorini and Valeria Sannucci. The new members of the Governing Board previously held positions of responsibility at the highest levels in the fields of monetary policy, financial stability, supervision, internal administration, and coordination of the activities connected with the Bank’s participation in the Eurosystem and the banking union project. The Bank of Italy is required to submit a yearly report on its activities to Parliament and the Government. Starting this year, the report has been enlarged and will be presented together with the annual report and financial statements. In this way we will be able to give a full account of the Bank’s operations and activities, its analyses, guidelines, administrative actions and organization. The fundamental responsibilities of the Bank of Italy for monetary policy within the Eurosystem and for supervising the national banking and financial system are well known. At the same time the Bank is a complex organization providing services that benefit both intermediaries and the general public. We administer the resources entrusted to us with diligence. The report on operations describes the steps taken to rationalize our procedures, improve the quality of our services and achieve greater efficiency. BIS central bankers’ speeches As a member of the Eurosystem, the Bank is involved in the payment systems, in the production of banknotes, and in ensuring the business continuity of common IT systems, often as lead institution in charge of joint activities and projects. Together with the three other largest central banks of the euro area we are creating a centralized platform for the settlement of securities transactions. At home, last year we made further progress in automating the centralized state treasury service and promoted the widespread adoption of the European format for payment services, thereby helping to cut costs and foster competition. Against a background of worsening economic conditions and risks for financial stability, we further strengthened our supervisory controls on banks and other intermediaries, stepped up inspections, and broadened our checks on compliance with the rules for consumer protection and against money laundering. The European Central Bank, the national central banks and the national supervisory authorities are working to create the single supervisory mechanism. This far-reaching institutional innovation will require an organizational adaptation as significant as, and even more complex than, the one leading to the single monetary policy. The project must capitalize on the best national practices; it must aim to achieve a common system of supervisory rules and practices ensuring pursuit of high and strict standards. We attach special importance to aspects that are a fundamental part of our tradition, such as the central role of inspections, methodologically robust analysis, and continuous discussion and dialogue with banks’ boards of directors and top management. The single supervisory mechanism will be based on the close integration of European and national structures in the case of the largest banks, and on the direct responsibility of national authorities – within the framework of common guidelines – for the rest; the tasks of customer protection, combating money laundering and supervision of non-bank intermediaries will continue to be conducted at national level. The delicate launch phase will require substantial investment in human and technical resources. The workload will not diminish, either for us or for the supervisory authorities of the other countries, as we strive to combine frameworks that differ in many respects. Concerning the events involving Monte dei Paschi di Siena, a detailed account of the supervisory initiatives and the measures adopted was made available on the Bank of Italy’s website at the end of January and has since been updated. Supervision of Monte dei Paschi has been continuous and increasingly stringent in recent years; the judicial authorities will assess whether this activity was obstructed by former directors and managers. From 2010 to 2012 we demanded that steps be taken to restore a balanced liquidity position, thereby staving off serious threats; we requested a marked strengthening of capital and of the internal control system; we prompted a radical change of management. We are working closely with the judiciary, to the benefit of our respective institutional objectives: safeguarding stability and suppressing illegal actions. The contribution of the Financial Intelligence Unit is fundamental. We have operated properly and with diligence and care, within the scope of the law; we welcome constructive comments. In 2012 the Bank of Italy considerably increased the volume of its assets, participating in exceptional single monetary policy interventions, particularly the expansion of bank refinancing operations. This has resulted in larger profits, but also in the need for greater precautionary allocations to risk provisions. The Treasury will receive a payment of €1.5 billion, on the basis of the Statute and subject to approval of the financial statements. The taxes owed by the Bank on its income and productive activities for the 2012 financial year amount to almost €2 billion. From 2008 to 2012 the Bank’s operating costs fell by more than 10 per cent; its staff was reduced by about 700 to just over 7,000. Technology has made possible large savings in resources and improvements in services in the payment sector. We have reduced internal administration and reinforced banking and financial supervision. The Governing Board and BIS central bankers’ speeches the Board of Directors agree on the objective of eliminating most of the Bank’s network at the provincial level. We have not ceased to recruit staff, using transparent and merit-based procedures, including innovative methods, to select highly qualified young people. Women account for 35 per cent of all personnel and 23 per cent of employees with managerial responsibilities; both percentages are rising. We promote gender equality in recruitment, in the assignment of positions and in career progression. We will continue to do so in the interest of good administration. I wish to convey my personal thanks and those of the Governing Board to the managers, directors and all the staff who work for the Bank of Italy, proudly performing their public duties with discipline and honour, as the Constitution requires; capable, when times are hard, of an outstanding, self-sacrificing commitment of effort, skill, passion, dedication and openness to change. The Bank and the country know they can count on them. Monetary policy in the euro area Conditions on the global financial markets have improved, but the world economy has yet to return to a steady growth path. The economic situation differs markedly in the main regions. The major emerging countries are still growing at rapid rates. Among the advanced countries, the United States appears to be gradually returning to the rates of growth that characterized the most recent expansions. In Japan, aggressively expansive policies, not devoid of risk, are seeking to stimulate economic activity. The euro area is struggling to pull out of recession: demand is dampened by the immediate effects of public and private deleveraging in many countries; cyclical weakness is spreading to the economies not directly exposed to the sovereign debt crisis. Recovery in the euro area requires help from every sphere of economic policy. Including by recourse to “unconventional” instruments, monetary policy has made an essential contribution to averting serious consequences for financial stability; it has safeguarded price stability. The tools of intervention have been chosen based on the characteristics of the financial system, the origin of the tensions and the institutional structure: we have aimed first and foremost to support the liquidity of the banks, which in the euro area, more than elsewhere, play a pre-eminent role in financing the economy, and to prevent sovereign debt market distortions from impeding the proper transmission of monetary policy. We remarked a year ago that the levels to which sovereign interest rates had risen in many countries of the area reflected not only the deterioration of national growth and fiscal prospects, but also a systemic risk factor, subsequently called “redenomination risk”, connected with fears of a break-up of the monetary union, due in part to the incompleteness of its institutional design. We documented this risk swiftly and analytically; our results have been confirmed by the studies of other institutions and have been adopted by the Eurosystem. At the end of June the summit meeting of euro-area heads of state and government approved flexible and efficient utilization of the financial support mechanisms – the European Financial Stability Facility and the European Stability Mechanism – to stabilize the financing conditions of the countries exposed to the sovereign debt tensions, provided they honoured their European commitments. The possible use of those mechanisms for the direct recapitalization of banks, after the creation of a single supervisory mechanism, was envisaged. In early August the ECB Governing Council announced the introduction of outright monetary transactions (OMTs) for purchases of government securities on the secondary market, with no quantitative limits. A few days before that the President of the ECB had promised to do whatever was necessary to safeguard the euro. In September the details of the scheme were defined. BIS central bankers’ speeches Countering the increase in interest rates on sovereign debt when that increase stems from redenomination risk and distorts the transmission of monetary policy falls fully within the Eurosystem’s mandate. The benefits of the announcements of the new measures were immediate: medium- and long-term yields came down in the countries under pressure; the fragmentation of markets along national lines lessened. The steps taken by the Eurosystem in the last two years have counteracted the worsening of credit conditions in the euro area and its repercussions on the macroeconomic situation. In Italy, according to our estimates, they have helped to buoy output by at least two and a half percentage points over that span. Our estimates, however, cannot measure the effects of the financial collapse that could have occurred in the absence of these interventions, with disastrous consequences for the national and European economies. In recent months the fears concerning the single currency’s survival and financial conditions in the area have abated further; one factor has been the expansion of global liquidity, which has spurred a search for high yields on the part of institutional investors. In Italy, interest rates on government securities have also declined on the longest maturities, returning to the levels prevailing at the beginning of 2010. Yet these advances have not been accompanied by an improvement of the real economy; economic activity continued to be weak throughout the euro area in the first quarter. Credit conditions still differ from country to country, owing not only to the diversity of macroeconomic situations but also to the residual uncertainty as to the future conditions of funding in the national banking systems. At the beginning of this month, considering the contraction of demand, the prospect of prolonged cyclical weakness and the decline of both actual and expected inflation in the medium term to well below 2 per cent, the ECB Governing Council lowered the rate on main refinancing operations further, taking it to a new historic low of 0.5 per cent. The Council reiterated that the unlimited supply of liquidity at fixed rates would continue for as long as necessary and in any case until July of next year. The ECB, in concert with other European institutions, is examining initiatives to promote a market in securities backed by loans to nonfinancial corporations. The Governing Council stands ready to intervene again as new information becomes available and to consider all possible measures for maintaining credit conditions throughout the area consistent with the monetary policy stance. The ECB’s management of official interest rates has proven effective; the effects of last year’s reductions have spread to the countries hardest hit by the tensions. The measures taken, in particular the announcement of outright monetary transactions, are conducive to the national and European reforms which alone can eradicate redenomination risk. Monetary policy can guarantee stability only if the area’s economic fundamentals and institutional architecture are consistent with that objective. Every country must do its part. The procedure for the activation of OMTs presupposes the emergence of very serious tensions; it can only be applied to countries that have previously requested, possibly on a precautionary basis, a European financial assistance programme, and it is subordinated to compliance with the conditions attached. These reflect the awareness that the fears of euro reversibility are not disjoined from those for the sustainability of the public debt and the growth prospects of individual countries. More than any conditionality, however, what is essential is the shared determination to advance towards a complete European Union: monetary union, banking union, fiscal union and finally political union. Important strides forward have already been taken. Under the pressing time constraints dictated by the crisis, there has been uncertainty, mistakes have been made, decisions have not been easy. But the way ahead is clear. We must proceed along the path of integration. The banking union project is designed to break the spiral between sovereign debt and the conditions of banks and credit. The BIS central bankers’ speeches importance of this has been further underscored by the handling earlier this year of the banking crisis in Cyprus, which was resolved only after problems of coordination between European and national authorities had emerged. The creation of a single banking supervisory mechanism in which the ECB and the national authorities play a pivotal role is the first step. It must be completed by rapid introduction of a common bank resolution scheme and common deposit insurance. The contours of the project for the common budget for the euro area must be defined and a timetable for its realization drawn up. The report of the European Commission last November and the one drafted by the presidents of the European Council, the Commission, the Eurogroup and the ECB move in this direction. The institution of common mechanisms of financial support for structural reforms in single member countries can constitute the occasion for the launch of the project and the issue, on a trial basis, of joint debt securities. The Italian economy Italy’s weak recovery following the global financial crisis ended in the second half of 2011, when our government securities market came under pressure. There ensued a vicious circle between the state of the public debt, of banks and credit, and of the real economy. Economic activity contracted by 2.4 per cent last year. This year too will register a substantial fall in output and employment. A cyclical upturn towards the end of the year is possible; it will depend on the acceleration of world trade, the implementation of appropriate economic policies, positive developments in expectations and investment conditions, and the availability of credit. The recession is deeply undercutting potential output and threatens to erode social cohesion. In 2012 Italy’s gross domestic product was 7 per cent smaller than in 2007, households’ disposable income was more than 9 per cent lower, and industrial production was down by a quarter. Hours worked were down 5.5 per cent, and more than half a million jobs had been lost. The unemployment rate, at 11.5 per cent this March, has practically doubled since 2007; it is nearly 40 per cent among young people and higher still among those in the South. The financial and international origins of the crisis, on which economic policy makers have mostly focused, must not blind us to the fact that in Italy more than in other countries the cyclical ups and downs are superimposed on serious structural weaknesses. In the ten years preceding the crisis, this was already evident in the overall performance of the Italian economy, which fared worse than those of nearly all the other major advanced countries. We failed to respond to the extraordinary geopolitical, technological and demographic changes of the last quarter-century. The adjustment required, and put off for so long, is historic in scope. It will affect the accumulation of tangible and intangible capital, product specialization and the organization of production, the education system, skills, career paths, the characteristics of the welfare system and income distribution, the positional rents that are incompatible with the new competitive environment, and the working of government. An adjustment of this magnitude needs a decisive contribution from the political system, but the response of society and all the forces of production is essential. Firms are called upon to make an exceptional effort to ensure the success of the transformation by investing resources of their own, seizing the opportunities for growth, adapting their corporate structures and organization, relying on innovation and their ability to hold their own in the most dynamic markets. They have demonstrated their ability to do so at other times in our history. Some are doing so now. But too few have been willing to take the plunge; at times, instead, the illusory solution of public support is advocated. This year’s Report contains a special section on innovation in Italy. The ability to renew products and processes, to export to emerging markets and to internationalize, including by heading or joining global production chains, divides the firms that are continuing to expand sales revenue and value added from those that, instead, are struggling to remain on the BIS central bankers’ speeches market. The recession has deepened this divide and made the inadequacy of some parts of the productive system glaringly obvious. Transferring activity from ailing to growing sectors and firms requires profound changes in employment relationships and in the education system. The point is not so much to foresee which sectors and activities will attract consumption and investment demand in the decades to come as to facilitate the transition, reduce the social costs, and capitalize on opportunities. Many occupations are disappearing; in the years to come young people cannot simply count on replacing their seniors as they retire. Now is the time to establish the right conditions for the birth and growth of new enterprises and to generate new job opportunities. Lifelong vocational training must be developed to cover working careers characterized by mobility and change, with workers safeguarded by reinforced safety nets and insurance systems, both public and private, during periods of inactivity. Schools and universities must support this process by ensuring education of adequate quality and quantity, acting with determination to raise levels of academic achievement and develop new skills. Italy needs conditions that are conducive to enterprise and to the reallocation of productive factors. The lag we have accumulated is accentuated by a redundant regulatory framework, by complex and costly administrative obligations that must be drastically reduced, law that must be rendered more certain, widespread corruption that must be stamped out, and insufficient protection from crime. Immediate, visible progress in removing these serious obstacles can stimulate productive investment, including from abroad, in all the country’s regions, especially in the South, where what is most critical is the environment for business activity, on which the balanced development of our economy ultimately depends. The programme of reforms launched in the last two years stems from these considerations. But in many instances, after the enactment of reform laws, the implementing measures have been slow to follow; in some cases they are still lacking and administrative practices remain unchanged. This is a recurrent feature of our country’s history: the chief difficulties reside not so much in the substance of the laws as in their effective application. The pace of reform has slackened in the past year, owing in part to the progressive deterioration of the political climate. In resuming the path of reform with determination – as the European Commission too urges in the recommendations accompanying the closure of the excessive deficit procedure – it is vital to adopt a comprehensive approach that fixes medium-term objectives from the outset. Structural reforms take time; they can be implemented in succession, provided that they are designed as part of a bigger picture that immediately clarifies their goals, implications and benefits. A credible programme can have an impact on expectations at once, dispelling uncertainties, fostering investor confidence and favouring the prospects of employment and income, above all for the young, who today find it difficult to imagine any future in our country. The consolidation of the public finances was also postponed for too long; in the face of demographic pressure on important expenditure items, the priorities for the allocation of resources were not clearly set. In 2007 public expenditure excluding interest payments was 43 per cent of GDP, two percentage points more than in 1997; the primary surplus had contracted by more than three points. In the same period in Germany primary expenditure decreased by more than four percentage points of GDP to just under 41 per cent. The response of budgetary policy in the wake of the collapse of Lehman Brothers was prudent in Italy: the support to economic activity in 2009 was provided through discretionary measures affecting the composition of the budget, without increasing the deficit. From 2010 onwards, the budgetary stance became restrictive. Following the explosion of sovereign risk, to avoid a potentially devastating confidence and liquidity crisis, in the second half of 2011 a correction to the public finances of the order of 5 per cent of GDP was introduced. This made it possible to bring the deficit down within the 3 per cent limit in 2012 and to aim at structural balance as early as this year. BIS central bankers’ speeches The adjustment had a negative impact on GDP growth in 2012 of about one percentage point. A larger impact, of about two points, resulted from the effects of the liquidity crisis on the cost and availability of credit for the private sector, the slowdown in world trade, and the increase in uncertainty and the related loss of confidence. The adjustment of the public finances helped to reduce the tensions on the government securities market, thereby preventing even worse developments. The advances made must be preserved. Squandering them would have grave consequences. It would be illusory to imagine we can overcome the crisis by means of budget deficits: investors and market participants allow us only a thin margin of confidence today. The volume of government securities to be placed every year to finance the deficit and, above all, to roll over the maturing debt is on the order of €400 billion. This year there is no room for any further increase in the deficit, since the margin available has been earmarked to pay general government’s commercial debts in relation to capital outlays. These payments can be brought forward, however, and those relating to current expenditure, which affect the debt but not the deficit, can be increased; above all, no new debts of this kind must be formed. The conditions need to be created for taking full advantage of the existing instruments and subsidies to enable young people to enter and remain in the labour market. The European Commission has undertaken to examine ways to allow national budgets to deviate temporarily from their medium-term objectives – keeping the deficit below 3 per cent of GDP – in order to finance investment projects, subject to specific conditions. In Italy, this could benefit investment to protect and enhance the value of the environment and our artistic and cultural heritage. Reductions in taxation, which are necessary in the medium term and which could be planned now, will necessarily be selective, giving priority to labour and production: the tax wedge on labour acts as a brake on employment and business activity. Tax evasion distorts the allocation of the factors of production, gives rise to unfair competition, hinders growth in firm size and increases the burden borne by law-abiding taxpayers. It needs to be fought at the supranational level as well. A significant contribution to better fiscal conduct can derive from the simplification and rationalization of taxes and formalities. The certainty of tax rules and their careful and balanced formulation can influence expectations, and hence demand, more and better than immediate tax cuts of uncertain sustainability. A reallocation of expenditure in favour of the more productive components is possible by pursuing improvements in efficiency and recoveries of resources across the board. If this method is adopted permanently, the functioning of general government can more nearly approach international standards. Significant results will not be possible without involving local government. Transferring resources on the basis of standard costs, with any excess expenditure borne by the local authorities concerned, encourages the dissemination of best practices. The efficient use of public resources requires a reassessment of the different levels of government, with the elimination of redundancies. The banks and lending The outlook for domestic demand also depends largely on credit access conditions. Lending to firms slowed sharply in the second part of 2011 and since the beginning of December of that year has contracted by about €60 billion. The decline, which was particularly abrupt at first owing to the banks’ severe difficulties in raising funds on the international markets due to heightened sovereign risk, continued at a more moderate pace during 2012; in the first four months of 2013 the contraction accelerated again, to nearly 4.0 per cent on an annual basis. Lending to households has also declined but less so. The cost of credit to firms, which rose in the course of 2011, declined for most of last year but stopped falling in the autumn. Bank lending rates are still higher than the euro-area average by about one percentage point for loans to firms and by half a point for mortgage loans to households. BIS central bankers’ speeches The banking system is the main source of funding for our economy. At the end of 2012 bank credit to firms and households amounted to just under €1.5 trillion, or 94 per cent of GDP; banks’ investment in government securities came to around €350 billion. The highly unfavourable state of the economy depresses credit demand today. The contraction in lending reflects the decline in business investment, the fall in purchases of durable goods and the weak property market. But the decline in lending is also due in significant measure to the tightening of supply, which is in turn linked to a deterioration in customer creditworthiness and its impact on banks’ asset quality. In turn, the credit supply conditions have an adverse effect on economic activity, creating a negative spiral that must be broken. The acute restriction of credit supply at the end of 2011 in response to funding difficulties was attenuated by the unlimited supply of three-year liquidity by the Eurosystem and by the increase in the range of the assets eligible as collateral for refinancing operations. The Bank of Italy allowed Italian counterparties to use less creditworthy illiquid assets, in this case charging all the associated risks to its own balance sheet. The collateral pledged with the Bank of Italy based on bank loans currently amounts to around €180 billion, which represents slightly less than a third of all the assets eligible for central bank refinancing and half of those actually in the collateral pool. Thanks to these measures immediate liquidity risks have been averted. The funds obtained through the three-year refinancing operations do not constitute a permanent resource, however. Tension on the government securities markets has not completely dissipated. There is still uncertainty regarding the banks’ ability to regain full access to the international markets, particularly the long-term segments. We are working, through discussions with the banks and in collaboration with the ECB, to expand the range of eligible assets. An increased risk of corporate default is driving up the interest rates on loans. Since the middle of 2012 this has offset the effect of the lowering of official rates and, more recently, of the decline in yields on government securities. The credit supply tensions seem to be affecting even firms with a balanced financial situation, albeit to a smaller degree. The difficulties are greatest for small and medium-sized firms, which are less able to tap other sources of finance. Gross issues of corporate bonds amounting to €35 billion last year were attributable almost exclusively to large groups. In 2012 the interest rate differential between bank loans of up to €1 million and those for larger amounts averaged 160 basis points, about twice the value recorded in the three years prior to the crisis. At the end of 2012 the stock of bad debt had risen to 7.2 per cent of total lending, compared with 3.4 per cent in 2007; and that of other non-performing loans to 6.3 per cent, up from 1.9 per cent. For corporate loans, the new bad debt ratio recently rose to over 4 per cent on a seasonally adjusted annual basis, a level not reached for twenty years. The leading indicators suggest that it will remain high until the end of 2013. The Government and trade associations have taken many steps in recent years to mitigate firms’ difficulty in obtaining credit and to meet their liquidity needs, strengthening measures already adopted and introducing new ones. Between 2009 and 2012 almost €60 billion in financial benefits was made available to small and medium-sized enterprises through debt moratoria and the interventions of Cassa Depositi e Prestiti and the Central Guarantee Fund. The Fund’s resources can be increased, taking care to ensure that the guarantees to be provided are for additional loans granted on more favourable conditions, and that beneficiary firms are fully informed about the public support measures. Faced with the deterioration of banks’ loans, the Bank of Italy has intensified its scrutiny of banks’ provisioning. Off-site and on-site checks have been conducted, with banks asked to continually assess the adequacy of the coverage ratio of their non-performing-loan and urged, when necessary, to take corrective measures. This action will continue, partly in conjunction with similar exercises agreed at international level, with a view to the creation of the single European supervisory mechanism. BIS central bankers’ speeches For the twenty large and medium-sized banking groups so far subjected to checks, coverage ratios ceased to fall and instead rose by two percentage points in the second half of 2012 to 44 per cent. Increases were recorded for the other banks as well. If the Bank of Italy’s supervision had been less incisive, the risks for the banks and for the economy would have been extremely serious. The promptness and credibility of supervisory action reassured international investors about the quality of Italian banks’ balance sheets, sparing Italy’s banks the destabilizing wave that struck other European banking systems and enabling them to continue to supply credit to households and firms. The coverage ratios reached must be maintained and in some cases raised. To minimize the procyclical effects of the interventions, we called on the banks to increase their internally generated resources by further curbing operating costs, dividends and executives’ and directors’ compensation, consistently with banks’ profitability and capital adequacy. For banks that will have to undertake more far-reaching adjustment, a contribution must come from the sale of non-strategic assets. A correction of the current tax penalization of value adjustments to loans would be opportune. The stretching out in time of their tax deductibility, which is not the rule in the major countries of the European Union, discourages lending to firms during economic downswings. Over the past five years the Italian banking system, starting from sound initial conditions, has weathered the global financial crisis, the instability of the sovereign debt market, and two deep recessions. Since the onset of the crisis, the highest quality capital has increased from 7.1 to 10.7 per cent of the entire banking system’s risk-weighted assets; for the five largest groups the ratio has risen from 5.7 to 10.9 per cent. The soundness and resilience of the Italian financial system were recently confirmed by the International Monetary Fund at the conclusion of its periodic financial sector assessment. The outcome of the IMF’s stress testing to date shows that our banks as a group are in a position to withstand shocks thanks to their capitalization and the liquidity provided by the Eurosystem. The Fund emphasized the fundamental contribution of supervisory action to systemic stability. The capital ratio gap between Italian banks and the European average, which has narrowed to about two percentage points, is due in large part to the massive injections of public capital to banks in other countries. In December government support to the banks amounted to 1.8 per cent of GDP in Germany, 4.3 per cent in Belgium, 5.1 per cent in the Netherlands, 5.5 per cent in Spain and 40 per cent in Ireland. In Italy it came to 0.3 per cent including the interventions in favour of Monte dei Paschi di Siena. These interventions, now being vetted by the Commission, were necessitated by the European Banking Authority’s recommendation that EU banks procure extraordinary, temporary supplementary capital buffers to cope with fluctuations in the value of their government securities holdings. These resources will also facilitate the restructuring plan adopted by Monte dei Paschi’s new management. The government has granted the bank a loan on onerous terms. The restructuring plan has ambitious objectives; its success will depend in part on economic and financial developments in the country as a whole. Italian banks’ financial leverage ratio (total balance-sheet assets over capital) is 14 to 1, compared with an average of 20 to 1 in the rest of the European Union. In the last two years the Italian banks taking part in the Basel Committee’s periodic monitoring have sharply reduced the additional capital they would need if the new “Basel III” requirements (including the capital conservation buffer) were fully in effect from €35 billion to €9 billion. Capital strengthening, transparency of accounting and rigorous risk evaluation criteria sustain investor confidence and help contain banks’ outside funding costs in particularly adverse circumstances. But the ultimate guarantee of banks’ stability is their capacity to generate earnings. Looking ahead, declining profitability threatens to weaken capital and undermine banks’ ability to finance the recovery of the real economy. Between 2007 and BIS central bankers’ speeches 2012 Italian banks’ return on equity declined. Last year it was 0.4 per cent net of extraordinary items in connection with goodwill impairments. The risk of unfavourable developments over the next few years must be countered first of all by effective action to curb costs. In a highly labour-intensive industry like banking, consideration must be given to measures, even temporary ones, to reduce staff costs in relation to revenue. The provision of the 2011 industry-wide labour contract for companylevel agreements to combine flexibility and solidarity moves in the right direction. In order to cope with contingent difficulties and actually preserve jobs, banks must proceed resolutely along this path. Change in the use of productive factors and in the channels of distribution must be promoted, fully exploiting the opportunities offered by the new technologies. In the last fifteen years the Internet channel has gained importance in relations with customers, but the impact on the traditional branch network has been limited. Differentiating between these two channels, one for standardized services and the other for more complex and customized products and services could help to reverse the Italian banking industry’s decade-long upward trend in costs as a proportion of revenues. In any event, customer trust remains fundamental. Progress has been made on this front, but further improvement is needed to enhance the quality and completeness of customer information, to ensure that the contractual terms as advertised correspond fully with those actually applied, and to prevent improper charges being levied on customers. The Bank of Italy has drawn up clear rules, compliance with which it verifies also by means of special inspections, imposing fines when irregularities are detected. For several years now, for individual disputes there is the Banking and Financial Ombudsman, acting through three territorial panels and independently of the Bank of Italy. It has proved to be effective and highly regarded. We intend to strengthen it further and are considering increasing the number of panels. Promptness of compliance with the Ombudsman’s decisions is one factor in the Bank of Italy’s assessment of banks. The difficulties in the financing of firms necessarily invite reflection on the overall structure of Italy’s financial system, the underdevelopment of the bond and equity markets and the consequent excessive dependence of firms on bank loans. As we have underscored on other occasions, this structure partly reflects Italian firms’ reluctance to go to the market, although the banks have not pressed them sufficiently to do so. The current situation demands that both sides overcome these hesitations. For solid businesses with good growth prospects, the difficult conditions of the market for bank credit are a powerful stimulus to tap the capital markets. On the banks’ side, an advanced financial system would enable them to diversify their sources of revenue, maintain a balanced loan-todeposit ratio and share the risks of financing customers with the markets. While paying due attention to conflicts of interest, banks can encourage firms’ recourse to the market by exploiting the advantage in assessing creditworthiness that derives from their long-term relationships. The capital strengthening of firms and their opening to the capital markets also require farreaching changes in the entire financial system. It is indispensable that the role of pension funds and other long-term investors be reinforced; appropriate incentives must be provided for the accumulation of equity capital. In the present difficult economic conditions and with the prospect of a comprehensive revision of banks’ business model, the role of shareholders is crucial. They will have to be able to support banks financially, by foregoing dividends if need be, carefully monitor their management without interfering, and accept dilution of control, where necessary encouraging mergers with other banks. They will be compensated by profitability in the longer term. In the crisis years banking foundations have supported the capital strengthening of some of the largest Italian banks. In their dealings with the banks in which they have an interest they BIS central bankers’ speeches must comply with the letter and the spirit of the law, refraining from influencing their operational decisions or organization; like any other shareholder, they must promote the choice of directors on the basis of competence and professionalism, by transparent criteria. The rules governing cooperative banks were drawn up for intermediaries whose business was restricted to a limited geographical area and marked, as in the case of mutual banks, by a high degree of mutuality. Today they may be inadequate for large intermediaries operating at national and even international level, listed on the stock exchange and with institutional investor shareholders representing a multitude of small savers whose aims and interests are unrelated to mutuality. For such intermediaries the rigid application of some aspects typical of the cooperative model may even detract from their ability to strengthen their capital. On several occasions we have indicated possible measures to facilitate the participation of shareholders and make institutional investors’ role more effective. It should be made easier for listed cooperative banks to turn themselves into companies limited by shares, when their size and the nature of their operations make this necessary. Within the scope of our powers, in order to ensure sound and prudent management, we promote changes in the application of governance practices; where the shortcomings are most serious, we require them. *** Europe and Italy are still navigating a difficult passage. To get through it we cannot relax our efforts; we must press on with the work of reform. European citizens must find in the strengthening of the Community framework a source of common identity, an understanding that everybody stands to benefit. For the countries that brought them into being, the single market and the economic and monetary union have represented an enormous opportunity for growth and stability, which needed – which needs – to be grasped in full. Some have not yet done so, Italy among them. On countless occasions our country has contributed ideas and policy initiatives to the European Community. It is part of our heritage of values and it is in our interest to continue to do so, in these difficult times, in which Europeans’ will to cooperate and to unite is sometimes called into question. We Italians, from the beginning among the creators of the European construction, must show that we know how to extricate ourselves from the grave condition into which we have fallen: jobs that are being lost and not being created; firms that are unable to modernize and finance themselves, that are closing; banks weakened first by the sovereign debt tensions and then by the effects of the recession, with some at risk of being in difficulty. Our political representatives are finding it hard to mediate between the general interest and particular interests; citizens are receiving conflicting and uncertain signals in this respect. We cannot always ask others to shoulder the burden of reform. All of us must do our share: firms, workers, banks, public institutions. A budget that, apart from cyclical contingencies, is in balance and whose composition fosters employment and growth is the prerequisite for every effective and equitable policy. The sacrifices made to achieve and consolidate financial stability are the consequence of long-ignored rigidities, lags accumulated over time. Italy’s release from the excessive deficit procedure is the first fruit of these sacrifices, an achievement not to be squandered. It should be viewed as an investment on which to build. We must not fear the future, be afraid of change. We can build nothing by defending entrenched positions and our own particular interests; all of us stand to lose. What is needed is awareness, solidarity and foresight. Measures and stimuli that are well-designed, even if they contemplate a not inconsiderable span of time for transforming the country, will engender the confidence needed to decide that today it is already worth the effort to commit oneself, to work, to invest. BIS central bankers’ speeches | bank of italy | 2,013 | 6 |
Address by Mr Fabio Panetta, Deputy Director General of the Bank of Italy, at the Federazione delle Banche di Credito Cooperativo Lazio Umbria Sardegna, "Reload Banking. La Banca del domani per un nuovo sviluppo dell'Italia", Rome, 21 June 2013. | Fabio Panetta: Credit and the financing of firms Address by Mr Fabio Panetta, Deputy Director General of the Bank of Italy, at the Federazione delle Banche di Credito Cooperativo Lazio Umbria Sardegna, “Reload Banking. La Banca del domani per un nuovo sviluppo dell’Italia”, Rome, 21 June 2013. * 1. * * The macroeconomic environment and the credit market Euro-area GDP continued to contract in the first quarter of 2013, with the cyclical weakness spreading across countries. Domestic demand is reflecting the impact of private and public sector deleveraging and the worsening of credit conditions. Exports declined for the second successive quarter. The cyclical indicators have shown a small improvement in recent months, although the levels are still low. According to Eurosystem forecasts, GDP will fall by 0.6 per cent over the year as a whole. In Italy the economic situation shows little sign of improving. In the first quarter of 2013 output contracted more than in the rest of the area, mainly owing to the decline in domestic demand. For the first time in four years exports decreased, in response to the reduction in demand from the other euro-area countries and a slowdown in sales outside Europe. Industrial production declined further in April before picking up slightly. Analysts expect the decline in GDP to ease during the present quarter; economic activity seems likely to stabilize in the second half of the year. According to OECD forecasts, GDP in Italy will fall by 1.8 per cent on average this year; this would bring the cumulative contraction since 2007 to around 8.5 percentage points, larger than that recorded during the Depression of the 1930s. Credit market conditions are one of the most critical aspects of the macroeconomic situation in Italy. In the first four months of this year lending to firms diminished by just under 4 per cent on an annual basis; lending to households also contracted, although to a lesser degree. The reduction in borrowing costs came to a halt last autumn, and lending rates are still above the euro-area average. Small and medium-sized enterprises face increasing difficulties. The decrease in lending reflects the weakness of demand for loans, which in turn is associated with the reduction in investment, the deterioration in consumer confidence and the weakness of the property market. But the reduction in bank credit, and the increase in its cost, can also be ascribed to the tightening of supply conditions. Evidence pointing in this direction comes from surveys of banks and businesses alike. Our estimates indicate that the deterioration in lending conditions, considering both the rise in loan rates and the diminished availability of credit, cut 1 percentage point from GDP growth in 2012. The main obstacle to loan supply is the increase in credit risk as the recession drags on. In the first quarter of 2013 the annual default rate rose to 2.8 per cent for total lending and to 4.5 per cent for lending to businesses. According to the leading indicators, the flow of bad debts will remain high for the rest of the year. The present state of the credit market is a well-known case in the economic literature: a situation in which uncertain economic outlook, high default risk and difficulty of assessing the soundness of individual borrowers generate adverse selection and heighten banks’ risk aversion, prompting restrictive lending policies.1 Unlike the pattern seen in the past, the J. Stiglitz and A. Weiss, “Credit Rationing in Markets with Imperfect Information”, The American Economic Review (1981). BIS central bankers’ speeches reduced availability of credit is also affecting, albeit to a lesser extent, large firms and firms with balanced financial positions. The credit market will continue to experience supply-side tensions in the months to come. Past experience has shown that loan quality tends to continue deteriorating long after the cyclical upswing has begun. Moreover, while the new regulations on banks’ capital and liquidity ratios will bring stability to the financial system once they are fully operational, in the short term they may act as a brake on loan growth. And market pressure on banks to reduce their reliance on wholesale funding also spurs banks to reduce the size of their balance sheets in a pro-cyclical manner. The first step towards setting the lending cycle in motion again – in the interest of firms and banks alike – is a firm commitment on the part of the banks to adopt lending policies that take fully into account their customers’ growth prospects. Each bank should be aware of the negative externalities for the whole Italian economy, and for itself, of an indiscriminate credit squeeze. Given the severe tensions that have emerged on the international financial and Italian sovereign debt markets in recent months, the capital strengthening prompted by the Bank of Italy’s supervisory action has allowed Italian banks to maintain investor confidence and attract external finance at low cost.2 However, this may not be sufficient, on its own, to overcome the credit supply bottlenecks. The “market failure” underlying the malfunctioning of the credit channel must be tackled by strengthening public guarantees in favour of firms without making the taxpayer shoulder too much of the associated risk and creating unfair advantages for the banks. The Government’s decision to reinforce the Guarantee Fund for small and medium-size enterprises is a step in the right direction. In implementing the measures, the Fund’s intervention must be made conditional on the actual disbursement of new loans, and more favourable conditions must be given to banks that demonstrate stronger growth in overall lending. Eligible beneficiaries must include firms with competitive potential and sound growth prospects, even if they are under financial strain. The guarantee must lead to a real improvement in the conditions applied to loans, and firms themselves must be allowed to apply directly for the Fund’s intervention. The effects on lending could be substantial: a €3 billion increase in the Fund’s capital would allow guarantees to be provided for some €40 billion worth of new loans. 2. The financing of firms The credit market tensions have highlighted once again the main weakness of Italy’s financial system: firms’ overdependence on bank credit and their inability to raise sufficient funds directly on the markets. The stock market is underdeveloped even compared with other bank-centred systems. The insufficient development of capital markets affects firms’ financial structure, which is marked by a fairly high proportion of debt provided mainly by banks; the weight of other financial instruments is correspondingly low. The recession is putting this model of financing under considerable strain. The reduction in business volumes means that firms are less able to finance investments with internally generated funds. Their reliance on the banks increases the tensions caused by the tightness of lending standards. In other countries, bond issuance serves to counterbalance the In order to minimize the pro-cyclical effects, the Bank of Italy has asked the banks to increase internally generated funds while continuing to reduce operating costs, dividends and directors’ and executives’ pay according to their profitability and capital base. For banks requiring stronger adjustment measures, a contribution must come from the sale of non-strategic assets. BIS central bankers’ speeches shortage of loans.3 In Italy, this option is only available to a few large corporations: €35 billion worth of bonds were issued in 2012, of which only €320 million by small and medium-sized firms. 2.1 The stock exchange and equity capital The underdeveloped stock exchange does not reflect a lack of firms eligible for listing. Italy has a large number of unlisted firms that fulfil the listing requirements as to size, capital and profitability.4 On a previous occasion I argued that the small number of companies participating in the capital market is above all the result of the decisions taken by entrepreneurs.5 Firms are reluctant to open up: growing in size and gaining access to the markets entail costs in terms of greater visibility to the tax authorities, supervisors and minority shareholders, in a situation of excessively heavy taxation, redundant and inefficiently applied administrative regulations and poorly flexible goods and labour markets. In the eyes of entrepreneurs, going public seems to imply a fixed cost in terms of transparency that outweighs the advantages of being able to source funds at competitive conditions from a broader range of investors. The small number of listed companies inhibits the development of financial instruments and services such as bonds and syndicated loans – financing techniques rarely used by unlisted companies, which by nature are less transparent and have only a small number of shareholders. Instead, once listed, Italian companies resort to bond issuance as often as companies listed in other countries: once they have covered the fixed cost of listing, Italian firms do not seem to have any difficulty turning to the capital market. Several attempts have been made in the past to increase the number of initial public offerings by offering tax relief for stock exchange listing or share issuance.6 Their lack of success has been due, at least in part, to their temporary nature and their inability to offset the permanent cost of stock exchange listing. Tax incentives that favour equity capital raising and listing can be effective if they are sufficiently large and, above all, permanent. The provision of the Allowance for Corporate Equity (ACE) can be supplemented in this direction: the tax deductibility of new equity capital invested in a company could be increased to eliminate the remaining tax advantage of debt.7 Additional incentives could be introduced for newly listed companies, creating a sort of See “Structural Issues Report 2013: Corporate Finance and Economic Activity in the Euro Area”, forthcoming in the European Central Banks’ Occasional Papers. See the “Documento tecnico programmatico” circulated by the Working Party on the listing of small and medium-sized firms set up by Consob with Borsa Italiana and other public and private associations and institutions. “Banche, Finanza Crescita”, paper given at the conference “Oltre la crisi: quale futuro per le banche italiane?”, organized by Associazione per lo Sviluppo degli Studi di Banca e Borsa in collaboration with Università Cattolica di Milano (2013). See also M. Pagano, F. Panetta and L. Zingales, “Why Do Companies Go Public?”, Journal of Finance, (1998) and F. Panetta, A. Generale and F. Signoretti, “The Causes and Consequences of Going Public. Firm-Level Evidence from Twelve European Countries”, paper given at the Bocconi-Consob conference (2013). Fiscal measures in favour of equity capital and stock exchange listing were introduced under the Visentini Law of 1983, the Tremonti Law of 1994, the Dual Income Tax (DIT) Law of 1997, and the “Tecno-Tremonti” Law of 2003. To eliminate the tax benefits associated with debt it might be enough, under certain conditions, to set the notional ACE rate equal to the long-term risk-free rate. See R. Boadway and N. Bruce, “A General Proposition on the Design of a Neutral Business Tax”, Journal of Public Economics (1984) and R. De Mooij, “Tax Biases to Debt Finance: Assessing the Problem, Finding Solutions”, Fiscal Studies (2011). BIS central bankers’ speeches “Super ACE”;8 available studies indicate that such a measure would have a considerable impact without necessarily crimping revenue significantly.9 The growth of the stock exchange would improve the efficiency of the entire Italian capital market, enhancing firms’ ability to finance medium- and long-term investments. 2.2 Non-bank finance So far, the recent abolition of the tax measures discouraging unlisted firms from bond issuance has had limited effects.10 The few placements made to date have been by mediumsized firms, largely to replace outstanding loans. This could reflect not only a traditional reluctance to enter the capital market,11 but also the fact that the smallest firms are still largely unaware of the new opportunities. Placements may therefore increase over time. The characteristics of the loans also act as a brake on issuance. Even once the system is fully operational, the small size of potential borrowers will tend to translate into bond placements of low amount, low liquidity, high risk and high return. These features make the individual operations unattractive to institutional investors, as well as to the issuers themselves. These problems can be overcome, or mitigated, by using suitable operators and techniques to diversify the idiosyncratic risks of debt instruments issued by small and medium-sized enterprises. In Italy emerging credit market tensions have led to the launch, in recent months, of several initiatives for investing in bonds, financial paper and loans of unlisted companies, most of them based on the closed-end fund. In general, these credit funds envisage a careful assessment of the issuers and active management of the portfolio over a medium-to-long horizon. The experience of other countries bears out the enormous potential of such funds.12 Securitization is another means of aggregating loans to small firms, helping to facilitate their indirect access to the markets. For banks, this instrument is essential in disposing of part of their assets and freeing up funds for new loans. The success of such initiatives depends on a high level of transparency, enabling final investors to manage the associated credit risk more efficiently than in the case of direct investment in single issues. Simple structures, low leverage and limited maturity transformation are essential. In the case of securitizations, there are advantages to be gained from Italy’s past experience, which has been extremely positive.13 The Super ACE would be equivalent to the Super DIT, which offered listed firms additional incentives with respect to the ordinary DIT. See A. Franzosi and E. Pellizzoni, “Gli effetti della quotazione. Evidenza dalle mid & small caps italiane”, BIt Notes (2005); G. Giudici and S. Paleari, “Should Firms Going Public Enjoy Tax Benefits?”, European Financial Management (2003); M. Geranio and E. Garcia, “Come sarebbe l’Italia con 1.000 società quotate?” (2012), mimeo, Bocconi. The Decree on Development abolishes the limit on the deductibility of interest payments on bonds and the 20 per cent withholding tax for non-resident holders, banks and institutional investors. The new rules also entail greater transparency for the issuing company as, for the tax benefits to be granted, the securities must be listed (if they are not listed, they must circulate among qualified investors). In the case of financial paper the issuer must submit to auditing; small and medium-sized firms must have a sponsor (bank, asset management company, investment firm) who is required to report the issue’s rating. For example, in January this year Ireland’s National Pensions Reserve Fund announced the creation of new funds for investment in small domestic firms amounting to € 850 million. See U. Albertazzi, G. Eramo, L. Gambacorta and C. Salleo, “Securitization is not that evil after all”, Banca d’Italia, Temi di discussione, No. 741 and BIS Working Paper, No. 341 (2011). BIS central bankers’ speeches There is considerable scope for institutional investors to expand their investments in private bonds, securitized loans and credit funds. Listed bonds of non-financial companies account for a very small share of the total portfolio of open-end investment funds, and the proportion of unlisted securities is well below regulatory limits; immediately accessible resources are estimated to amount to between €6 billion and €10 billion; much larger amounts would be available with a liquid market for securities. Moreover, large-scale investments may also be made by insurance companies, pension funds and closed-end funds. Without a sufficient supply of securities of Italian firms, many institutional investors could well turn to foreign markets. 3. Mutual banks Italy’s 394 mutual banks and 3 mutual-bank central credit institutions account for 10 per cent of loans to households and firms, a bigger share than the third largest Italian banking group. This role of mutual banks is even more important in the case of small firms, accounting for almost 20 per cent of total lending. The mutual banks had greatly expanded their activity prior to the recession. From 1995 to 2008 their market share of lending rose by nearly 9 percentage points for small firms, 5 points for large firms and 3 points for households. As emphasized on previous occasions, 14 underlying this expansion are knowledge of the local markets, experience in assessing the creditworthiness of small borrowers, and an ability to meet customers’ needs promptly and efficiently. Mutual banks stabilized the supply of loans even during the 2008–09 recession: their sound capital base and stable funding enabled them to provide financial support to the small and medium-sized firms subjected to rationing by the large banks. More recently, the unfavourable economic situation and financial market tensions have altered this scenario. The mutual banks are now experiencing difficulties. In the second half of 2011 their liquidity situation suffered the backlash of the sovereign debt crisis: in October their overall net interbank position turned negative for the first time. The tensions eased in 2012 following central bank intervention, to which the mutual banks had made ample recourse; the good performance of deposits also contributed. The growth in lending has progressively weakened in recent months, turning negative at the beginning of this year, partly as a result of the tightening of supply conditions. Mutual banks are experiencing a deterioration in loan quality. In 2012 the stock of bad debts rose by 25 per cent, that of other non-performing loans by almost a third; non-performing loans represent 14.4 per cent of total lending, compared with 13.5 per cent for the banking system as a whole. The difficulties are severe for the smallest mutual banks and for those that have expanded rapidly in recent times; the problems have become widespread in a number of regions such as Calabria and Veneto. These trends have a particularly serious impact on mutual banks, which derive most of their earnings from traditional banking activity.15 Because of their local vocation, they are deeply aware of the need to choose between supporting the local economy – of which they are part – by continuing to provide loans to firms in temporary difficulty and adopting more selective supply policies in order to safeguard their own stability. See the address by the then Governor Mario Draghi “Solidarietà nella crisi Il credito cooperativo nelle economie locali” given on the occasion of the 50th anniversary of Crediumbria, Città della Pieve, December 2009. In the last four years net interest income has accounted for 70 per cent of gross income, 15 percentage points more than the average for the banking system. In 2012 interest on loans was unchanged from the previous year while funding costs and loan loss provisions increased. BIS central bankers’ speeches The recession has brought to light the weaknesses of the mutual banks’ business model: rigid costs, reliance on income from traditional intermediation, loan concentration. Even the growth strategies pursued in the past that allowed them to greatly expand the areas and customer segments served16 have been shown in recent years to amplify risk. The size and the quality of mutual banks’ capital are still fairly high. However, the decline in profitability reduces their self-financing, virtually the only channel by which mutual banks can increase their own funds. The gap with respect to the largest banks, a competitive advantage that the mutual banks have long enjoyed, is gradually narrowing. To achieve the necessary efficiency gains and keep profitability and capitalization levels high over the long term the organizational structures and business models of these banks need to be overhauled. Incisive action must be taken to reduce costs, as is being done in the other banks. In the last four years administrative costs have risen by 5 per cent and staff costs by 9 per cent. These trends are at odds with the prospects of income growth. Business models must be found that respect the banks’ local roots but can diversify their sources of income towards services, thus avoiding overdependence on lending to the local economy. Given the small size of mutual banks, this strategy should make use of their association network. It is essential to maximize the potential synergies created by this network comprising the national federation and local federations and by the industry’s structures – three central credit institutions and the various specialized companies. The services provided by the local federations vary greatly in scope, quality and efficiency. In some areas, the assistance offered to member banks is inadequate; problems of organization of the federations can hinder the resolution of bank crises. The industry’s network is also plagued by inefficiencies associated with the highly fragmented supply structure; there is a very pressing need in particular for more highly integrated information systems. Action must be taken to preserve mutual banks’ patrimony of knowledge and their role serving the local economy, to which they are tied by a profound community of interests. The Bank of Italy has already underscored the need to raise the levels of efficiency and has urged the coordination structures of the mutual banks’ associations and industry network to play a more active role.17 It is crucial to strengthen the system’s cohesiveness. The Institutional Guarantee Fund must represent a decisive step in that direction. The project’s complexity has necessitated preparatory action on several fronts both within the Fund and as part of a dialogue with the Bank of Italy. The testing phase is about to begin, to devise and put in place effective organizational and operating mechanisms and efficient links with the supervisory authorities. Once the project is fully operational, it will still require a strong commitment to ensure that its objectives are actually achieved in terms of improved crisis prevention, strengthening of the network and dissemination of best practices. In November Governor Visco, in commenting on the appropriateness of a reorganization of the mutual banking network, stressed that the Fund project, though innovative, could not represent a point of arrival.18 The need to make the system more cohesive calls for projects From 2000 to 2008 a fifth of the growth in lending concerned customers acquired in new districts; moreover, loans to firms with over 20 employees rose from 46 to 61 per cent of the total (a proportion that has since stabilized). See the speeches “Il credito cooperativo: le sfide di un modello” and “Il credito cooperativo del domani: sviluppo, efficienza e solidarietà” by the then Deputy Director of the Bank of Italy, Anna Maria Tarantola, to, respectively, the Annual Meeting of the Italian Federation of Mutual Banks (November 2009) and the XIV National Congress of Mutual Banks (December 2011). Ignazio Visco, “Borghi, distretti e banche locali”. Presentation of the volume Civiltà dei borghi: culla di cooperazione”, Rome, 20 November 2012. BIS central bankers’ speeches of broad conception that take account of the experiences of the mutual and cooperative banking systems in Europe, which are characterized by a high degree of integration. The Bank of Italy is open to a discussion of the different options, including as regards regulation. Conclusion The Italian economy is at a difficult passage in which cyclical weaknesses are overlaid on unresolved structural problems. The country’s growth potential is diminishing; the loss of jobs, particularly among younger persons, and the reduction in households’ purchasing power are breeding discouragement and depleting human capital. There is no room to support growth through deficit spending. The large burden of the public debt and the tensions in the financial markets do not allow it. Some measures, discussed in the Governor’s Concluding Remarks to the Bank of Italy’s Annual Meeting, can assist a struggling productive economy and bolster the prospect of cyclical upswing. But above all we must resume, with the contribution of all the country’s best talents and resources, the reform programme begun in the last two years. We can no longer postpone modernizing our productive structure, our education and research system, the functioning of public administration. The obstacles to competition and innovation must be extirpated in all sectors. The rationalization of public expenditure, its reallocation towards more productive uses, must permit a sharp reduction in the tax burden on our economy. The banking system must play its part. There can be no enduring recovery without adequate financial support to firms. The effects of the recession on banks’ balance sheets, on the availability of credit, must be counteracted with vigorous action to rationalize costs, innovate business models, strengthen the ability to select sound firms with competitive business projects. The tensions in credit supply increase the incentives for firms’ to access and make greater use of the capital market. The diversification of sources of financing demands an important commitment from entrepreneurs to make financial statements transparent, open up to outside investors, strengthen the equity capital base. The markets would be unwilling today to support opaque or undercapitalized initiatives. The development of the capital markets is in the interest of the banks themselves. By offering advisory services for direct financing, they can reinforce, not weaken, their customer relationships with firms and their own role within a more diversified financial system. And in this way they can trace the path for returning to growth. BIS central bankers’ speeches | bank of italy | 2,013 | 7 |
Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the Annual Meeting of the Italian Banking Association, Rome, 10 July 2013. | Ignazio Visco: Overview of Italy’s economy and banking system Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the Annual Meeting of the Italian Banking Association, Rome, 10 July 2013. * * * The economic climate and outlook In the first half of 2013 Italy’s GDP again diminished, largely owing to the fall in domestic demand; exports also declined. Our forecasts, which will be published in the Economic Bulletin in a week’s time, put the contraction of GDP this year at close to two per cent. Economic activity is expected to begin to expand at a moderate pace from the end of the year, with overall growth of more than half a percentage point in 2014. In the short term, domestic demand will have to be buoyed by the timely payment of general government commercial debts. The level of uncertainty is high. The timing and strength of the recovery are subject to the risk of a slowdown in the global economy, in particular in the emerging economies, together with the risks inherent in financial market developments. Italy’s large public debt and weak growth prospects, as well as the uncertainties over European governance, make risk premiums on government securities highly sensitive to swings in market confidence, as has been shown recently by the wide fluctuations in interest rate spreads relative to German Bunds. A deterioration would further narrow the scope for fiscal policy measures and would have repercussions on banks’ funding and hence on the availability and cost of credit to firms and households. We cannot risk losing investors’ confidence, which is fragile and exposed to the changeable evaluations of analysts. Budgetary policies must continue to be responsible; the reforms already decided and those still to be implemented should be set within a comprehensive design and the aims clearly defined. Monetary policy will sustain the recovery. On 4 July the ECB Governing Council announced that monetary conditions would continue to be accommodative for as long as necessary. It adopted innovative communication procedures, specifying that it expects official rates to be kept at or below their current levels for an extended period of time given the subdued outlook for inflation, the weakness of economic activity and modest monetary growth in the euro area. The Italian banking system has been under severe strain from the financial crisis, the doubledip recession and sovereign debt tensions. The banks’ income-producing capacity has been reduced; in the absence of an adequate response it would be further undermined by the persistence of the crisis or the occurrence of new adverse shocks. Credit The contraction of lending to firms intensified in the first half of this year, to an annual pace of over 5 per cent in the three months ending in May. The decline in lending to households was less severe, amounting to 1.6 per cent. The average interest rate on new business and house purchase loans remained the same as at the start of the year, at just over 3.5 per cent. The spread over the euro-area average did not change significantly, hovering around three quarters of a percentage point. The cyclical downswing is squeezing credit demand. It is aggravating debtors’ repayment difficulties: in the first quarter the new bad debt ratio for business loans was around 4.5 per cent, which was high in historical terms; other impaired loans are also increasing sharply. Heightened risk is weighing on banks’ credit supply policies, discouraging lending and driving up interest rates. This can be seen in the surveys conducted with banks and firms alike. The BIS central bankers’ speeches strains will continue over the next few months; past experience indicates that the deterioration in loan quality tends to continue beyond the start of a cyclical upturn. Above all, the difficulties affect small firms, which have less opportunity to access the capital markets. The Government’s recent changes to the workings of the Guarantee Fund for small and medium-sized enterprises are a step in the right direction. The implementing provisions should allow firms with good growth prospects to apply to the Fund, even in the face of a temporary recession-induced deterioration in their accounts. The guarantees should be made conditional on the effective granting of loans, with more favourable terms provided for banks showing better overall credit growth. The availability of guarantees must translate into an actual improvement in credit terms, enabling firms themselves to apply directly to the Fund. On 1 July the Italian Banking Association and the country’s trade associations signed a new agreement allowing firms in difficulty to obtain a temporary suspension of repayments of medium- and long-term loans and an extension of loan maturities, and to be granted new loans if they increase their capital. The Bank of Italy will make sure that the moratorium provides support for deserving firms without concealing the actual riskiness of the loans. Past experience in this regard has been positive. Italian banks must guard themselves against the risk of a worsening of their funding conditions. The supply of assets eligible for use in Eurosystem refinancing operations is now very substantial thanks in part to a large volume of public guarantees on bank bonds, which will mature in the next few years, however. Going forward, the supply must be maintained by increasing the share of eligible assets, among other things by adding new types. Great care must be taken to ensure that loan granting procedures meet the requirements for Eurosystem refinancing. In the coming weeks we will call on the banks for an examination of the steps to be taken. In several cases Italian banks not only provide finance, they also participate directly in the capital of firms. This can lead to a more accurate assessment of a firm’s growth prospects and a better evaluation of its financial needs. However, a participating interest can sometimes distort lending decisions; as the size of shareholdings and loans increases, there is the risk of collusion or of actions designed to delay the surfacing of difficulties. The banks’ governing bodies must properly safeguard against these risks: to maintain loan quality and keep banking profitable, in the banks’ own interest; to protect the value of the savings entrusted to them, in the interest of their customers; and above all to ensure the efficient allocation of savings and boost the competitiveness of the productive economy. In January the legislation on related-party transactions came into force. It aims to protect banks from potential conflicts of interest with closely connected parties; it provides a necessary counterweight to the European rules easing the restrictions on the links between banks and industry. The limits on exposure to each related party are calculated in relation both to the amount of credit granted and to the size of the bank’s shareholding in the company. The decision-making process on these matters must be transparent and correct and the outcome suitably motivated. The banks must be scrupulous in applying the new rules. The Bank of Italy will evaluate the effectiveness of the measures they adopt; when necessary, it will intervene, possibly by setting stricter limits and conditions for related-party transactions. The difficulties besetting the credit system highlight once again firms’ overdependence on bank lending. By international standards Italian firms are undercapitalized, make very limited use of the capital market, and tend to limit scrutiny by investors. The credit market tensions will persist in the months to come. Bank loans cannot be the sole source of external finance, as they are at present for most firms. The financing of investment must also tap new resources as well. It is in the banks’ interest to encourage this process by BIS central bankers’ speeches seeking to maintain a balance between loans and deposits, sharing the risks of financing customers with the markets, and carefully avoiding potential conflicts of interest. Above all, it is necessary for firms to increase their equity. The tax deductibility of new equity capital invested in a company, which was introduced in 2011 under the rules on the Allowance for Corporate Equity (ACE), could be increased, in order to eliminate the remaining tax advantage of debt. The financial soundness of firms and their ability to finance medium- and long-term investments would benefit significantly. Asset quality and capital International analysts’ fears about the soundness of Italian banks’ balance sheets should not be underestimated, even though they are not always well justified. The policies undertaken to curb costs, improve risk management and strengthen banks’ capital base must continue. Our ongoing intervention concerning the adequacy of provisioning for non-performing loans aims to ensure a satisfactory level of risk coverage; it will enable the banks to preserve investor confidence and attract low-cost external financing. It is essential in order to guarantee a satisfactory flow of credit to households and firms. The stock of impaired assets, which reached 14 per cent of total loans in March, remains high in part owing to the slowness of credit recovery procedures. Another factor is the exceptionally long time it takes for loan write-downs to become tax deductible. By international standards, the representation of loan quality on balance sheets reflects a prudent definition of impaired assets. In the mid-1990s, when the ratio of bad debts to loans was higher than it is now, the reduction in the stock of impaired loans was favoured by the development of a market in these assets, with the participation of foreign investors. Initiatives of this sort could be successful today, provided that transparency is guaranteed and that the mechanisms of risk transfer from banks to investors are fully consistent with prudential rules and accounting standards, permitting the definitive cancellation from banks’ balance sheets of the impaired assets transferred. Over the last few difficult years the Italian banking system has strengthened its capital base considerably. Banks’ ability to withstand adverse shocks has improved. The increase in highquality capital needed to satisfy the capital adequacy requirements envisaged by the Basel III rules that will be phased in by 2019, which was €35 billion at the end of 2010, dropped below €9 billion last December; already today most of the largest intermediaries would meet the new prudential requirements. Still, capital strengthening must continue. While this may automatically reduce the return on capital, at the same time it favours its stability. By increasing banks’ ability to withstand adverse shocks it boosts investor confidence and lowers the cost of external funding. Exposure to the public sector has increased significantly since the beginning of 2012. Contributory factors included the high risk of loans, the objective of expanding the supply of collateral eligible for refinancing operations with the central bank, and the high yields on government securities. Widespread among banks, these purchases were concentrated in securities with an original maturity of three years or less and were mostly recorded in the banking book. Economic recovery and a return to normal conditions in the credit market will enable fund allocation policies to return to what they were before the crisis and permit an expansion of lending to households and firms. Banks’ stability is also founded on appropriate risk management and control systems: organizational shortcomings prevent the correct allocation of capital, encourage the unwitting assumption of risks, render the institution vulnerable to violations of internal norms and procedures, and expose intermediaries to potentially severe reputational damage. BIS central bankers’ speeches In recent days the Bank of Italy has issued new supervisory provisions on banks’ internal control systems. The new rules require that governing bodies be fully involved in the design of risk management and control systems, the determination of “tolerated risk” and the approval of key decisions, such as offering new products, undertaking new business or entering new markets. They also underscore the need to ensure the independence and authority of the control functions. The banks will be granted sufficient time to adapt and must inform the supervisory authorities of the measures they intend to adopt. Profitability and governance The events of recent years have depressed banks’ profitability and their ability to generate the resources needed to increase capital and thereby support the financing of the economy. In the banking industry, which is labour-intensive, wage levels and dynamics must be made fully consistent with the objective of preserving banks’ stability. Careful consideration must be given to measures, possibly temporary, aimed at significantly reducing staff costs in relation to revenues. There must be full awareness of the constraints stemming from the difficulties that the banking system currently faces, a change of pace to deal with contingent difficulties for intermediaries, including with a view to safeguarding employment. The effort to adapt productive factors and distribution channels to the opportunities offered by new technology must be stepped up. In recent years banks have become aware of the importance of corporate governance. Ahead of global regulatory developments, the Bank of Italy has issued rules on governance and stiffened them over time. It has urged the adoption of best practices and intervened repeatedly with corrective actions. Progress in this direction must continue. A number of unresolved problems remain to be tackled. I addressed two – the role of the banking foundations and the governance of cooperative banks – in my concluding remarks last May. Here I would like to offer some further considerations. In most cases the presence of the foundations among banks’ shareholders has fostered stability. During the crisis, in the absence of other large investors, some of them underwrote very substantial capital increases. At this point foundations should be encouraged to diversify their investment portfolios, so as to loosen their sometimes excessive dependence on the performance of their reference bank and prevent interference in banks’ governance and business choices. This would be conducive to the inclusion of new investors in the banks’ shareholder base. Analyses of banks’ bylaws, shareholder pacts and shareholders’ behaviour at general meetings have shown that some foundations tend to interpret shareholders’ prerogatives very extensively indeed. This has produced excesses, at times impeding the necessary turnover within the governing bodies and causing directors to be chosen according to criteria other than professional qualifications. Episodes of this sort have an adverse effect on banks’ performance, limiting their ability to finance the economy. Measures to prevent their recurrence must be taken as soon as possible. The Charter adopted by the association of savings banks and foundations in 2012 calls for transparency in the criteria and procedures for appointing the members of foundations’ decision-making bodies. It establishes waiting periods and incompatibility conditions with respect to previously held political positions. It sets experience and independence requirements for the top officers of foundations and also of the banks in which they hold stakes. These indications must be made fully effective. They must also be strengthened by prohibiting passage from top positions in foundations to those in banks. BIS central bankers’ speeches The ban on controlling stakes to which the largest foundations are subject must be fully observed, if necessary by redefining control in such a way as to cover its exercise on a de facto basis or jointly with other shareholders. Adequate measures for enforcement of the ban must be instituted. Incompatibility with other positions and stricter requirements for bank directors also need to be provided for. The imminent application of the fourth revision of the capital adequacy directive offers the occasion for reinforcing the standards of experience, independence and reputation for banks’ corporate officers and enabling the supervisory authorities to intervene, when the situation so requires, including by removal from office. The application of the rules on transactions with related parties, which I mentioned earlier, will also help to guarantee the independence of the banks against undue interference and influence. The cooperative banks, in recent years, have experienced a healthy process of membership renewal. The increase in widespread share ownership and the greater presence of institutional investors have strengthened their capital. These changes now require a review of the cooperatives’ governance arrangements, which were originally conceived for small, local banks and are not suited to today’s large institutions with a substantial national presence and a broad membership base or stock exchange listing. For the largest of these banks the rigid application of some of the rules typical of cooperatives – one person one vote, share ownership ceilings, approval clauses for new members – may have negative effects on the quality of governance and the capacity for capital strengthening. In the absence of adequate counterweights, a fragmented and dispersed shareholder base is likely to result in low attendance at meetings and a lack of incentive to monitor the performance of the directors. Within our powers, we have intervened in respect of cooperative banks’ bylaws to encourage an increase in the number of proxies that may be conferred on a member, to limit the fragmentation of holdings and to remove the obstacles to institutional investors’ presentation of candidates when governing bodies are renewed. Important as they may be, however, these actions cannot resolve the structural governance problems of the cooperative banks, especially the largest ones. It is necessary to embark on a course of gradual but incisive reform. Considering, among other things, the prospect of banking union and the changeover to a single supervisory mechanism, the more noticeable and unjustified are the differences vis-à-vis the other large banks, the more sudden could be the call for change. The revision of governance structures can be pursued in two directions. First, shareholders’ control of management’s activity must be enhanced and the injection of capital by new members encouraged. The transparency and effectiveness of management must be ensured by increasing shareholders’ awareness of risk-taking, by combating potential conflicts of interest. Expectations of sure profits and, for unlisted cooperative banks, of easy disposal of shares must not be engendered. Institutional investors, whose presence confers stability thanks to their long investment horizon, must be given adequate representation in the bodies charged with supervisory functions. Sound and prudent management demands that the presence of current and former employees in the shareholding structure should not influence management policies and decisions. Second, there should be no hesitation to change the bank’s legal form. International authorities and investors concur that the limited share company is the model most consistent with the characteristics of large banks, encouraging contributions of capital and fostering transparency of ownership structures and governance. The larger cooperative banks must open up to this transformation, easing the way by setting realistically achievable quorums for their general meetings. The revision of governance is essential to ensuring informed risk management, a correct allocation of credit to the economy and an efficacious management of conflicts of interest. By BIS central bankers’ speeches removing the obstacles to capital strengthening, it will reassure investors as to the banks’ ability to cope with the difficult macroeconomic context and growing competition. The banking union The work to create a single supervisor in the euro-area, consisting of the ECB and the national authorities is proceeding expeditiously. Starting out from the national authorities’ store of technical knowledge, the new institution will have to ensure a supranational vision based on best practices in supervisory methodologies, modelling and assessment of banking risks. The transition to the single supervisory mechanism will give stability to the euro area, helping to counter the trend towards the segmentation of the financial markets along national lines, which we have seen during the crisis. It will facilitate comparisons between the banks and systems of the different countries. On 20 June the Eurogroup reached an agreement on the possibility of using the resources of the European Stability Mechanism (ESM) to recapitalize banks directly under certain stringent conditions for a maximum of up to €60 billion. This will be conditional on the launch of the single supervisory mechanism, which in turn will have to be preceded by a balance sheet assessment of the banks subject to centralized supervision at European level and, in particular, by an asset quality review. In the following days the Ecofin Council reached a general agreement on the rules for the recovery and resolution of banks in crisis. The procedures whereby creditors are to share the costs of a banking crisis were decided, with entry into force scheduled for 2018. These so-called bail-in mechanisms are consistent with the recommendations of the Financial Stability Board aimed at curbing opportunistic behaviour and limiting the costs of bank crises for taxpayers. The agreement specified the bank liabilities covered by a creditor bail- in and the order in which they will be called on to participate. At national level, a minimum share of liabilities able to ensure sufficient loss-absorbing capacity will be established for each bank. In addition, it was decided to set up national resolution funds financed by the banks themselves; within ten years these funds must have an endowment equal to 0.8 per cent of the deposits covered by the respective deposit guarantee schemes. Only if a number of conditions are met and if there are severe risks for the system’s financial stability may public funds also be used. Recourse to the resolution fund − allowed when the bail-in process makes available resources equal to at least 8 per cent of the bank’s liabilities − enables account to be taken of national specificities, such as the widespread use of retail bond funding in Italy. The work to establish the fund must proceed rapidly, with appropriate negotiations with national and Community authorities. The transition phase must be completed well before the time limit of ten years indicated in the agreement, while assessing the scope for synergies with the entities already in place. When the fund is fully operational, the availability of adequate resources will allow the cost of crises to be divided between the bank’s creditors and the banking system as a whole, with advantages for the cost of banks’ funding. The agreements reached are an important step towards banking union but they do not break the vicious circle between the conditions of sovereigns and banks or eliminate the fragmentation of financial markets along national lines. A European resolution mechanism must be created as soon as possible, based on a single resolution authority and pooled resources, able to cope with systemic crises and prevent contagion. The possibility of using ESM funds to recapitalize banks directly has in practice been postponed for many months, since it depends on the entry into operation of the single European supervisor. There remains the possibility of using such funds indirectly, by means of ESM loans to member states, but recapitalizing banks in this way bears on the public debt of the countries concerned. BIS central bankers’ speeches The asset quality review of euro-area banks that will be carried out in the coming months will make heavy demands on the participating countries’ supervisory authorities. It will have to be based on common rules and methodologies and valuation methods that are uniform across countries. We are confident of the outcome of this exercise, aimed at eliminating doubts about banks’ solidity. In Italy analyses of this kind are routinely part of both on- and off-site supervision. The inspections carried out recently at twenty intermediaries made it possible to assess the adequacy of their loan loss provisions and to request corrective action where necessary. The same action is now being taken at other intermediaries. The methods used provide an example of how such analyses can be conducted. Any capital shortfall that emerges for some European intermediaries will be met in the first place with private-sector resources. Prompted by supervisory authorities, banks will have to take appropriate action to meet their needs, such as restricting the distribution of dividends or disposing of non-strategic assets. The definition of an adequate financial back-stop, to be established ex ante, will be necessary to prevent deleveraging. The asset quality review will be followed, in 2014, by stress tests conducted by the European Banking Authority and the ECB to assess banks’ ability to withstand low-probability extreme shocks. The similar exercises performed by the IMF under its Financial Sector Assessment Program (FSAP) show that, all told, the capital of the Italian banking system is well above the regulatory minimum and meets the capital requirements established for the Basel III phase-in period. However, given the low level of profits, in extreme circumstances capital buffers could be rapidly depleted. These results confirm the need to carry on the process of capital strengthening. *** The Italian economy remains in a difficult transition phase. To pass through it successfully requires a universal effort. The banking system must play its part. There cannot be a lasting recovery in the absence of sufficient financial support for firms. To counter the effects of the recession on their accounts, banks must press ahead with measures to improve their profitability and strengthen their capital. To ensure an adequate flow of funds to the real economy, they must take account of their clients’ growth prospects. Intermediaries must be fully aware of the positive effects of this on the Italian economy and of the advantages for themselves. BIS central bankers’ speeches | bank of italy | 2,013 | 7 |
Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the 32nd Seminar "Federalism in Europe and in the World", Istituto di Studi Federalisti "Altiero Spinelli", Ventotene, 1 September 2013. | Ignazio Visco: The sovereign debt crisis and the process of European integration Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the 32nd Seminar “Federalism in Europe and in the World”, Istituto di Studi Federalisti “Altiero Spinelli”, Ventotene, 1 September 2013. * * * The introduction of the euro was a fundamental step in European history, a political event that certified the progress made on the road to integration, a profound economic and social change. It was only a step, however, and not the end of the road, which is still a long and difficult one. Tommaso Padoa-Schioppa, who contributed so much to the achievement of monetary union, was well aware of this. In May 1998, on the eve of the introduction of the single currency, Padoa-Schioppa wrote in the Corriere della Sera, The European economic and monetary union’s “capability for macroeconomic policy is, with the exception of the monetary field, embryonic and unbalanced […]. For the European Central Bank the real danger will not be too little independence but too much isolation […], having to operate almost in a vacuum, with no political power, budgetary policy, banking supervision, or financial market control function. […].It is thus right not only to applaud yesterday’s step but also to underline its unfinished nature, the risks and the rashness.” Since 2010 this incompleteness has fueled the sovereign debt crisis in the euro area. In the absence of political union, the economic governance of the area was based on a fragile alliance between market forces and rules of conduct. Market forces were to ensure the economic convergence of the member countries and the definition and implementation of the necessary structural reforms at national level. Rules of conduct were expected to guarantee prudent budgetary policies. As early as the 1989 Delors Report, it was thought that, for the public finances, “the constraints imposed by market forces might either be too slow and weak or too sudden and disruptive.” Economic convergence was slow and difficult; in some cases the gaps actually widened. In many economies the delays and obstacles to adjusting to the large-scale global changes weakened competitiveness and the ability to grow. Mitigated by the improvement in funding conditions after the introduction of the euro, market pressures alone were not sufficient to drive the necessary reform efforts. Measured on the basis of unit labour costs in the whole economy, the loss of competitiveness recorded between 1999 and 2008 in the countries worst hit by the crisis went from about 9 percentage points in Greece and Portugal to 12 points in Italy, 19 points in Spain, and no less than 37 points in Ireland. Considering only manufacturing industry and competitiveness indicators based on producer prices, the competitiveness losses ranged from 7 percentage points in Italy to 22 points in Portugal (14 points in Spain, 16 points in Ireland and 18 points in Greece). The rules for the public finances defined in the European sphere were not always respected. In 2007, almost a decade after the introduction of the single currency, only a few countries reported budgets close to balance in structural terms, i.e. not counting the effects of the economic cycle on revenue and expenditure. In some cases the public debt was still at an excessively high level in relation to GDP. For a long time the financial markets underestimated sovereign risks, thus confirming the doubts about their ability to provide timely incentives for the adoption of virtuous behaviour. Until the outbreak of the crisis the spreads between government bond yields within the euro area were close to zero. In this framework, after the financial crisis in the United States and the very severe global recession in 2008–09, the full revelation of the unsustainability of the Greek public finances produced tensions which then spread to the economically weaker euro-area countries, characterized by excessive public or private debt, a foreign trade deficit, poor competitiveness, and low economic growth. Tensions grew with the bursting of the property BIS central bankers’ speeches bubble and the consequent disruption of banking in Ireland. With the announcement of the involvement of private investors in restructuring Greek debt in the summer of 2011, the financial markets suddenly became aware of the implications of the ban on interventions to rescue member states under the Treaty on European Union. There followed a very serious crisis of confidence in the ability of the single currency to survive, with negative consequences for the real economies of individual countries and for the area as a whole. The yield spreads between euro-area government securities suddenly increased in the second half of 2011; those between Italian and German 10-year government bonds, still below 200 basis points in the first half of that year, rose to 550 points in the following November. In the same period, in Italy and the other countries affected by the tensions, there was a sudden worsening in wholesale funding conditions for banks, whose creditworthiness was linked to that of their sovereign paper; placement of securities, especially uncovered bonds, dried up; the CD and commercial paper markets also thinned. The cost of fundraising rose; in the money market there was a significant increase in the spreads between the very-short-term interest paid by Italian banks and the average. Given the real risk of a severe tightening of the supply of credit to the economy, the Governing Council of the ECB cut its main refinancing rate by a total of 50 basis points in November and December 2011, introduced three-year refinancing operations (LTROs) providing unlimited liquidity at fixed rates, extended the range of assets eligible as collateral, and halved the compulsory reserve ratio. In the two LTROs conducted in December 2011 and February 2012 the Eurosystem supplied funds totaling around €1 trillion to banks in the euro area; taking account of the smaller volume of funds disbursed in other operations, the net increase in the flow of resources to the banking system exceeded €500 billion. The large injection of liquidity contributed to easing tensions in the money market. The excess liquidity is currently being reabsorbed: deposits held in the ECB’s reserve accounts and deposit facility, excluding the compulsory reserve, now amount to €250 billion, down from €800 billion in March 2012. Yield spreads between government bonds in the euro area are determined by two factors, one national and one European, linked respectively to the weaknesses of some countries’ economies and public finances (sustainability risk), and to the incompleteness of European construction and the attendant fears of a break-up of the monetary union (redenomination risk). Europe’s response to the sovereign debt crisis has consequently been two-pronged: on the one hand, individual countries have pledged to adopt prudent budgetary policies and structural reforms to support competiveness; on the other, a far-reaching reform of EU economic governance has been undertaken. Not every country needed to consolidate its public accounts; in some cases in the international fora there was even talk of the possibility of expansionary interventions. Adjustment was indispensable in countries such as Italy that were experiencing difficulty in the financial markets and where the margin of confidence granted by investors and market operators was especially narrow. As I have remarked elsewhere, the volume of government securities to be placed every year to finance Italy’s deficit and, above all, to roll over the maturing debt is in the order of €400 billion. The recession has made budget corrections difficult, with their inevitably negative repercussions for economic activity in the short term. Nonetheless, prudent management of the public accounts has helped to avoid worse scenarios, to first limit and then lower interest rate differentials between euro-area government securities, and to prevent new liquidity crises. It has also proved difficult to implement structural reforms since, while helping to restore the growth potential of an economy, they can have short-term costs, especially in terms of employment. Between the summers of 2011 and 2012 the Bank of Italy’s assessment of the prospects for growth in Italy last year gradually deteriorated by over 3 percentage points; one point is attributable to the effect of public finance measures, while more than one and a half points BIS central bankers’ speeches reflects the increase in the spread between Italian and German government securities and its effect on the supply of credit to the economy and on business and consumer confidence; the remainder is attributable to the darkening outlook for world economic growth. The financial results of Italy’s fiscal policy have been obscured by the recession. Notwithstanding an increase in the primary surplus – to 2.5 per cent of GDP, from 1.2 per cent in 2011 – government debt has risen by over 6 percentage points of GDP, to 127 per cent, reflecting above all the sharp deceleration in output. Almost two percentage points of the increase are attributable to the financial support that Italy has given to other EU countries. The reform of European governance, which took shape in emergency conditions, along lines that were not always consistent and marked by uncertainty, overlap and heavy-handedness, along with the efforts made at national level, have nonetheless begun the process of rebuilding trust among member states. In the past, the Union’s cohesion has been severely tested by repeated violations of budgetary rules – not only in relation to the most recent events, but also for those that led to the first reform of the Stability and Growth Pact in 2005 – and by the difficulty of making any in-depth assessment of national financial systems, which are subject to profoundly different regulations and supervisory practices. The strengthening of the budgetary rules, above all as regards prevention, and the extension of multilateral supervision to macroeconomic imbalances have accompanied the establishment of mechanisms for managing sovereign debt crises and paved the way for the launch of the banking union, renewing discussion on the budgetary union and plans for a political one. The agreements reached in the last two years in the matter of public finances have reinforced the commitments entered into previously but they have not established more demanding targets. The new European governance has increased the automatism of coherence checks on policies and objectives and of potential sanctions; countries have been asked to recognize the European rules in their national legislation. Even the “debt rule”, which calls on countries to reduce by 1/20th annually the amount by which their debt exceeds the threshold of 60 per cent of GDP, in fact renders operational a requirement already embodied in the Treaty of Maastricht. For Italy, compliance would not entail the adoption of a permanently restrictive budget policy stance, but it does imply the return to a stable growth path and it requires a faster pace of adjustment to the geopolitical, technological and demographic changes of the past thirty years. The new macroeconomic imbalance surveillance procedure is an early warning mechanism based on a scoreboard of indicators and alert thresholds. The indicators are analyzed by the European Commission in an annual report identifying the countries to be subjected to indepth review. In the case of particularly severe imbalances, the Commission draws up, for approval by the European Council, a set of specific recommendations calling for adjustment measures; failure to comply may lead to sanctions. Until two years ago Europe had no tools with which to manage a sovereign crisis. The first measures to support Greece, and to a smaller extent Ireland, involved the use of bilateral loans. In May 2010 the European Financial Stability Facility (EFSF) was instituted – a temporary mechanism that was also adopted for Portugal and has remained in operation until this year; the bonds issued under the facility are guaranteed by the member states. In July 2011 the EFSF was flanked by the European Stability Mechanism (ESM), a permanent crisis management tool instituted by international treaty and endowed with capital of its own; ESM loans to Spain were used to bolster the country’s banking system. The total lending capacity of these two instruments, initially set at €250 billion, has been raised progressively to €700 billion. When the EFSF was launched the only method of intervention available was to grant loans under support plans for the countries in difficulty; this has gradually been extended and now includes, with appropriate conditionality, interventions on the primary and secondary markets for government securities, opening of precautionary credit lines, and funding of the recapitalization of financial institutions. BIS central bankers’ speeches Between 2010 and 2012 the countries of Europe disbursed, either directly or through the EFSF or the ESM, some €280 billion in loans to their partners in difficulty. Italy contributed €43 billion, of which €27 billion for EFSF loans, €10 billion for bilateral loans and €6 billion to provide capital for the ESM. According to official estimates our contribution will rise to more than €55 billion this year and to almost €62 billion in 2014. After the need to remedy the asymmetry of a single monetary policy and multiple national budget and structural policies had been recognized, a further gradual reinforcement of the Economic and Monetary Union was agreed and set in motion. The Blueprint for a Deep and Genuine Economic and Monetary Union published by the European Commission last November and the report Towards a Genuine Economic and Monetary Union presented in June 2012 and updated in December by the President of the European Council, working closely with the Presidents of the European Commission, the Eurogroup and the ECB, outline the stages of this process. They will lead to banking union, the introduction of autonomous fiscal capacity for the whole euro area, a common budget and, eventually, political union. The time needed to implement Europe’s complex strategy to counter the economic crisis will be long. The distortions that continue to affect the financial markets in the meantime could undermine the transmission of monetary policy and jeopardize the entire process. In July 2012 the yield differential between 10-year BTPs and the equivalent German Bunds was just over 500 basis points, compared with a value of about 200 basis points estimated to be consistent with Italian and German economic fundamentals. Aware of these dangers, in the summer of 2012 the ECB Governing Council announced the introduction of a new method of intervention on the secondary market for government securities, Outright Monetary Transactions (OMTs). Countering an excessive increase in sovereign yields when it stems from redenomination risk and distorts monetary policy transmission is fully within the Eurosystem’s mandate. The OMTs are only activated in the presence of severe market strains and are confined to the securities of countries adhering to a macroeconomic adjustment or precautionary ESM programme. Their continued operation then depends on observing the conditions attached to the programme. There are no ex ante limitations on the duration or amount of the intervention. This initiative has been made possible by the credibility of the Eurosystem and the progress made in the reform of European governance. Fears of euro reversibility are linked in the first place to those concerning the sustainability of public debts and the competitiveness of member countries. For this reason the activation of OMTs and their continuation are subject to specific undertakings regarding public finances and structural reforms as part of assistance programmes. The financing of the programmes with ESM resources is an incentive to further strengthen the governance of the Union, which is essential to achieve a permanent reduction in the European component of the differentials. Monetary policy can guarantee stability only if the euro-area’s economic fundamentals and institutional architecture are consistent with it. Every country must do its part. The announcement of OMTs produced immediate benefits: medium and long-term yields in the countries under pressure decreased and the fragmentation of markets along national borders was attenuated. Albeit with fluctuations linked to the remaining, pronounced uncertainty about the determination of all the member states to proceed with the strengthening of the Union, the yield spreads between euro-area government securities remained on a downward trend. That between ten-year BTPs and Bunds is about 250 basis points today. On 19 July a group of economists of various nationalities and affiliations published a manifesto in support of outright monetary transactions (A Call for support for the European Central Bank’s OMT Programme), arguing that “the success of the OMT announcement proves that the OMT is primarily a monetary policy instrument … It is the responsibility of a BIS central bankers’ speeches central bank and a defining feature of a lender of last resort to assume liquidity risk, including through the purchase of financial assets when necessary (a step that has also been used by the Bundesbank itself in the past).” There are different standpoints; it is understandable that some should question the compatibility of outright monetary transactions with the constitutions of some euro-area countries, but the doubts about the possibility of making effective use of ESM resources must be dispelled quickly in order to preserve the progress made, safeguard the rights and not thwart the efforts of those who have helped to develop the instruments of financial support. The OMT announcement prevented a financial collapse with potentially devastating consequences for the European economy: all the member countries benefited, not just those at the centre of the sovereign debt crisis. More than anything else, however, a shared determination to advance towards a full European Union is essential. The ECB and the national central banks have shown that they are willing to accompany this advance, by continuing to “produce” the necessary confidence. But confidence is short-lived in the absence of real progress. The handling at the beginning of this year of the Cyprus banking crisis, which was only resolved after difficulties of coordination between European and national authorities had emerged, further underscored the importance of the banking union project for interrupting the spiral between sovereign debt and the conditions of banks and credit. The creation of a single supervisor, in which the ECB and the national authorities play a pivotal role, is the first step; it must be completed by a common blueprint for the resolution of banking crises and a common form of deposit insurance. Beyond banking union there must be the prospect of fiscal union and, ultimately, political union. In an interview he gave to la Repubblica on 6 October 2008, Padoa-Schioppa noted that “There is more bitterness than satisfaction in witnessing a prophecy come true. At the beginning of the euro I spoke of the dangers of a ‘currency without a State’. It is clear that we needed more of a European State, not less of a European currency: without the euro, Europe would now be living a catastrophe. One reason for the lack of credibility of national politics is that it keeps on giving people the illusion that national powers are capable of tackling issues (energy, climate, finance, security, migration, primary goods) which are not national, but continental and global.” These words, spoken before the outbreak of the sovereign debt crisis, are highly relevant. It is necessary to further increase the coordination of economic and structural policies and the incentives for reforms, to shift from an intergovernmental form of management based on the peer review of national policies to the formulation of truly common policies. The scope of the project for a common euro-area budget must be defined as well as the timeframe for its implementation. Economic and political reforms are not interdependent: confidence in the outlook for Economic and Monetary Union would benefit greatly from significant new steps towards political integration, including on a sectoral basis. In an essay written forty-five years ago (“Tecnologia ed economia nella controversia sul divario tra America ed Europa”) Nino Andreatta had already stressed the importance of a serious assessment of the “adverse consequences of a plurality of national government purchasing policies, which encourage an inefficient multiplication of research by individual countries and slow the growth in the size of markets.” The reflection on the desirability and necessity of going beyond the stage of comparison and cooperation and of our governments pooling institutions and policies that also have a major impact on our public finances – in fields such as defence, scientific research, infrastructure (and not just material infrastructure) and other fundamental sectors of government activity – has been under way for some time, the time is ripe for a process of concrete reform. BIS central bankers’ speeches | bank of italy | 2,013 | 9 |
Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the conference "Europe and the future of global governance", organized by the Italian Institute of International Affairs and the US Council on Foreign Relations, Rome, 10 September 2013. | Ignazio Visco: The exit from the euro crisis – opportunities and challenges of the Banking Union Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the conference “Europe and the future of global governance”, organized by the Italian Institute of International Affairs and the US Council on Foreign Relations, Rome, 10 September 2013. * * * The euro area has suffered two recessions in the last five years. GDP contracted for five consecutive quarters starting in the spring of 2008; the fall came to more than 4 percent in 2009. The subsequent recovery was short-lived: the outbreak of the sovereign debt crisis in mid-2011 was followed by six quarterly declines. In 2012, GDP was still 1.3 percent less than in 2007. The signs now are that the contraction is drawing to a close. GDP resumed moderate growth in the second quarter of this year, reflecting the expansion of exports and progress in domestic demand, and the confidence indicators improved somewhat over the summer. Actual and expected inflation remain subdued, well below 2 percent. However, the timing and strength of the recovery are still highly uncertain. The resolve with which European and national authorities continue to implement the reform strategy devised to deal with the crisis will be decisive for financial conditions and for business and consumer confidence. Externally, the slowdown in the emerging economies and the recent geopolitical tensions in the Middle East threaten to undermine the prospects for world demand. The crisis did not hit all the euro-area countries in the same way, and the recovery is correspondingly asymmetrical. In Italy the recession has been longer and deeper than in most other countries. Last year’s output was almost 7 percent less than in 2007. In the first half of 2013 GDP diminished again, but at a slower pace, with exports still providing the main stimulus. The latest indicators are consistent with gradual improvement: the decline in output should come to a halt in the coming months. The downside risks to this scenario are compounded by investors’ concerns about possible political instability. The spark that ignited the sovereign debt crisis in the euro area at the end of 2009 was the unveiling of the dramatic state of the public finances in Greece. But the tensions soon fed on the economic weaknesses of other member states – macroeconomic imbalances, real-estate bubbles, distressed financial systems, high public debt. The crisis became systemic in the summer of 2011 with the announcement of the involvement of private investors in restructuring the Greek debt, which made the markets suddenly aware of the implications of the no bail-out clause in the EU Treaty. These events laid bare the incompleteness of the European construction, the euro being a “money without a state”. The spreads between the government bond yields of the fiscally weak countries and the German Bund soared. A serious crisis of confidence in the very survival of the single currency ensued, with adverse consequences for the real economy. The situation deteriorated most severely in the banking systems of the countries most directly affected by the tensions, whose perceived credit standing soon aligned with that of their sovereigns; wholesale funding conditions deteriorated sharply, cross-border interbank lending all but dried up. There emerged a perverse loop between fragile public finances, weak economic performance, and deteriorating bank conditions. Given the risk of a severe credit tightening, the Governing Council of the ECB took resolute action. With two special refinancing operations in December 2011 and February 2012 the Eurosystem supplied banks with a trillion euros in three-year funds (over €500 billion net of the volume of funds reimbursed in other refinancing operations). The liquidity injection was effective: sovereign spreads dropped and the wholesale markets revived. BIS central bankers’ speeches Europe’s response to the sovereign debt crisis has been twofold. Domestically, to rein in the risks from unsustainable public finances, individual countries have committed to prudent fiscal policies and structural reform to enhance competitiveness. At European Union level, to dispel the fears of euro break-up and “redenomination risk”, a reform of economic governance has been undertaken. National action on the sovereign debt crisis has been heterogeneous. Fiscal adjustment was indispensable in the more economically fragile countries, including Italy, to ward off the risk of losing access to the market, which would have precipitated the crisis. Its negative shortterm effect on economic activity was the price paid for averting more serious consequences. With the benefit of hindsight it is clear that the reform of European governance was long overdue. The long-dormant process was effectively set in motion by the sovereign debt crisis. Despite hesitancy, overlaps and redundancies, within a very short span of time definite progress has been achieved. Together with the efforts at national level, the reform of European governance has begun to rebuild trust among member states. The strengthening of the budgetary rules, which has reinforced existing commitments and made them more credible without imposing more demanding targets, and the extension of multilateral supervision to macroeconomic imbalances have accompanied the institution of mechanisms for managing sovereign debt crises and paved the way for discussion with a view to deepening European integration. Until recently, Europe lacked the tools for managing a sovereign crisis. Between 2010 and 2012 EU countries disbursed some €280 billion in loans to their partners in difficulty, either directly or through the newly established common financing instruments (the European Financial Stability Facility, EFSF, and the European Stability Mechanism, ESM). Italy’s contribution amounted to €43 billion, which according to official estimates will rise to more than €60 billion in 2014. The European reforms are still in the making. Their full pay-off, as well as the reward for national efforts, will come in the medium term. In the meantime, the distortions still affecting the financial markets could undermine the transmission of monetary policy and jeopardize the entire process. This risk materialized in the spring of 2012 when sovereign spreads started widening again. By July the differential between 10-year Italian BTPs and the equivalent German Bunds had once more exceeded 500 basis points, against the value of about 200 points then estimated to be consistent with the two countries’ economic fundamentals. The ECB Governing Council reacted by announcing Outright Monetary Transactions (OMTs), a new method of intervention on the secondary market for government securities whose purpose is to counter excessive increases in sovereign yields where they stem from redenomination risk and distort monetary policy transmission; as such, they are fully within the Eurosystem’s mandate. The announcement of OMTs produced immediate benefits: medium- and long-term yields in the countries under pressure decreased and the fragmentation of markets along national lines was attenuated. OMTs were made possible not only by the credibility of the Eurosystem but also by the very process of reform they intend to protect. The fears of euro reversibility are linked in the first place to concerns about the sustainability of the public debt and the competitiveness of some member countries. For this reason the activation and continuation of OMTs are subject to specific commitments regarding the public finances and structural reform, as part of assistance programmes. The financing of the programmes with the ESM’s resources is an incentive to strengthen the governance of the Union further. Monetary policy can guarantee stability only if the euro area’s economic fundamentals and institutional architecture are consistent with it. Confidence in the irreversibility of the euro is the key. In the short term, the effective use of ESM resources will preserve the progress made and safeguard the rights and the efforts of BIS central bankers’ speeches those who have helped to develop the instruments of financial support. The OMT announcement prevented a financial collapse with potentially ruinous consequences for the European economy: all the member countries benefited, not just those at the centre of the sovereign debt crisis. Towards deeper European integration: the Banking Union To ensure stability over the longer run, the effort to reform the European governance has been stepped up. The subsequent stages are outlined in the report Towards a Genuine Economic and Monetary Union (presented in June 2012 and updated in December by the President of the European Council, working closely with the Presidents of the European Commission, the Eurogroup and the ECB) and in the Blueprint for a Deep and Genuine Economic and Monetary Union published by the Commission last November. Both documents envisage a banking union, the introduction of autonomous fiscal capacity for the whole euro area, and a common budget; they set the scene for the eventual political union. A keystone of institutional reform, Banking Union is crucial to break the perverse feedback loop between sovereigns and domestic banking systems. It has three key components: a single supervisor, a single bank resolution mechanism, and a single deposit insurance scheme. In the summer of 2012 the European leaders decided to give priority to the construction of the first component, the Single Supervisory Mechanism. The SSM comprises the ECB and the national supervisory authorities. For the largest banks it will be based on strict integration of European and national structures. For the others, it will involve the direct responsibility of national authorities, under common guidelines; the ECB will retain the right to take over direct supervision responsibilities where circumstances warrant. This far-reaching institutional innovation will require an organizational adaptation as far-reaching and at least as complex as that leading to the single monetary policy. The delicate launch phase will require substantial investment in human resources and technical infrastructure. The national supervisory authorities’ workload will not diminish, as we strive to build a unitary new mechanism from frameworks that differ in many respects. The preparatory work is proceeding at the greatest speed compatible with the challenges of the task. Building on the technical experience and reputation of national authorities, the SSM will have to ensure a supranational vision. Supervisory practices within the euro area are quite heterogeneous. It is vital to avoid any lowering of standards and instead to converge on the best practices in supervisory methodology, modelling and assessment of banking risks. This will ensure early warning of emerging instability at individual banks and at systemic level. We attach special importance to aspects that are a fundamental part of the tradition of the Bank of Italy, such as the central role of on-site inspections, methodologically robust quantitative analysis, and close interaction with banks. If successfully managed, the SSM will bring substantial benefits to the single market: it will improve the effectiveness of monetary policy transmission, counter the ring-fencing trends observed in the last years, thus fostering financial integration, facilitate comparison between banks and banking systems in different countries, and in this way improve the monitoring, control and mitigation of vulnerability factors. Work is also continuing on the single resolution mechanism (SRM), the second component of the banking union. This is indispensable to align the responsibilities for supervising banks and handling crises. The Bank Recovery and Resolution Directive is intended to harmonize the heterogeneous national practices, rules and tools for bank crisis management and keep rescue operations from being financed with public funds. The Directive lays down a number of preventive measures, together with rules for timely intervention and resolution, including the bail-in of bank creditors. A fund to be financed by the banks themselves will be earmarked for bank resolution. The European Commission recently issued a proposal for a Regulation – which should be fully operational in 2015 – to institute an SRM under a single BIS central bankers’ speeches resolution authority and with pooled resources. Concerning the third component of the Banking Union, a draft directive has been prepared to implement a common network of national deposit guarantee schemes by the end of this year. The institution of the SRM must proceed expeditiously, with appropriate negotiations between national and Community authorities. Once the mechanism is fully operational, the availability of adequate resources will allow the cost of crises to be divided between the bank’s shareholders, creditors and the banking system as a whole. During the transition to the SRM, the risk of a vicious circle between a fiscally weak sovereign state and its fragile domestic banks persists. The ESM will only be able to directly recapitalize banks – with the aim of restoring their viability and obtaining a remuneration of the capital invested – after the effective entry into operation of the SSM. There remains the possibility of using ESM funds indirectly, by means of loans to member states, but this would bear on the public debt of the countries concerned, bringing the bank-sovereign loop back into the picture. The comprehensive assessment of the main European banks … With a view to the launch of the SSM, the ECB and the national supervisory authorities are working to undertake a comprehensive assessment of the soundness of the significant euroarea banks, those that will fall under the direct supervision of the SSM. This assessment consists of thorough analysis of each bank’s risk profile, comprising an overall balance-sheet assessment (BSA), including an asset quality review, and a stress test. The exercise will also cover other relevant aspects of banks’ business, including leverage, corporate governance and organization. The comprehensive assessment is designed to make sure that the area’s main banks are managed in a sound and prudent manner, helping to dispel market concerns over their soundness and risk profiles. Significantly, from the outset the assessment will also foster confidence in the SSM itself, reinforcing mutual trust among participating countries. It will therefore be a fundamental step in normalizing wholesale markets and restoring the banking system to its principal, fundamental role of supporting economic activity and growth. In order to attain these objectives, the comprehensive assessment must be completely transparent, as regards not only results but also process and methodologies. The appropriate involvement of external reviewers may enhance the credibility of the exercise. Attention must obviously be paid to potential conflicts of interest and problems of confidentiality. Also, level-playing-field issues among participating banks must be avoided. The design of the balance-sheet assessment must recognize that national accounting and supervisory practices differ radically, especially in the definition and measurement of nonperforming loans (NPLs). The European Banking Authority (EBA) is working to make definitions uniform across systems and has recently issued a consultation paper on the matter. This is a step in the right direction and should be finalized in time for its results to be used for the BSA. In any case, the BSA requires a de facto harmonization of NPL definitions. National practices also differ substantially in the measurement of risk-weighted assets, the denominator of regulatory capital ratios. Differences in the models used by banks to compute capital requirements – or in the approaches adopted by supervisors for validating them – may undermine the comparability of banks’ capital, so the BSA will have to pay close attention to the way in which these models compute the risk weights of different categories of assets, including off-balance-sheet items and “level 3” assets (non-traded assets whose fair value is estimated through internal models). Again in this case, de facto harmonization is necessary. Furthermore, in order to be fully credible and to be perceived as a confidence-building exercise the comprehensive assessment must be rigorously designed and carried out, with clearly defined and well motivated thresholds for gauging any capital shortfalls. If, as BIS central bankers’ speeches observed earlier, one of the objectives of the Banking Union is to break the perverse feedback loop between banks and sovereigns, then an essential prerequisite is the presence of adequate backstops against the capital shortfalls that may emerge from the BSA. Also, to avoid pro-cyclical effects, clear and extensive communication of the process and its results is necessary. The mistakes of the past in the sequence of the actions taken by different policy makers should not be repeated. … and a perspective on the Italian banking system The Italian banking system offers a few illuminating examples of the problems and challenges of the comprehensive assessment. In the international comparison Italian banks appear to have a high NPL ratio and a low coverage ratio (i.e., the ratio of loan loss provisions to gross non-performing loans). But it is clear by now that the comparison is vitiated by disparities in accounting and supervisory practices, which must be taken into account in order to obtain a fair assessment. A case in point is the treatment of collateralized loans. Some major European banks do not classify fully collateralized loans as NPLs, while in Italy loans are classified on the basis of the borrower’s creditworthiness, irrespective of collateral or guarantees. Both practices are fully consistent with international accounting standards enforced in Europe, but the Italian method makes the bank’s balance sheet more transparent for investors. If Italian banks used the same definition as some foreign banks, their stock of non-performing loans would fall by about a third, decreasing their average NPL ratio significantly and raising their coverage ratio; at the same time, the rise in the NPL ratio in the recent years would be less accentuated, reflecting the sharp increase in collateral demanded by Italian banks in reaction to the deteriorating economic outlook. Let me be clear: I am not suggesting a relaxation of the Italian definition of NPLs – which, by the way, is broadly in line with the one proposed in the EBA consultation paper. I am arguing that the BSA needs to take this and other sources of heterogeneity into account. Similar considerations apply to leverage. Italian banks have lower leverage than their international competitors, partly because of their relatively small volume of business in derivatives. Arguably, their operational risks are also comparatively low: Italian banks have not been involved in any of the serious episodes of malpractice or the market-rigging schemes that have damaged the reputation and of some foreign intermediaries and cost them expensive legal settlements. These and other sources of heterogeneity, which tend to bias international comparisons against Italian banks, have been documented by the Bank of Italy in its Financial Stability Report as well as by market analysis. They will have to be duly taken into account in the comprehensive assessment. These arguments are intended simply to support a fair approach to the forthcoming BSA; they are not meant to downplay the risks that the Italian banking system faces. While Italian banks have demonstrated good resilience overall, thanks to their sound fundamentals at the outset of the financial crisis, the sovereign crisis and two long and deep recessions have put their balance sheets under severe stress. NPLs have been rising steadily since 2008, depressing profitability and raising concerns over provisioning among analysts and market operators. And even though I have set out the reasons why we need to quickly enhance comparability among European banks, we take these concerns seriously. Indeed, we have taken decisive action to address these risks, and we are confident that this will improve the outlook for the Italian credit market. Apart from episodes of malfeasance, which are relevant but circumscribed, serious difficulties mainly concern a handful of medium-sized and small banking groups. This class of banks has been particularly hard-hit by the recession, owing among other things to lesser diversification of risks and revenues. Additional challenges have sometimes been raised by weak ownership and corporate governance structures, which may complicate capital strengthening and adaptation of business models. Intense supervisory actions have been BIS central bankers’ speeches – and continue to be – taken on these banks. In some instances special administration has been necessary to allow a clear recovery and return rapidly to ordinary management. The Bank of Italy regularly reviews banks’ asset quality as part of its standard supervisory activity, assessing the risk exposure of each institution. The quality of banks’ assets is assessed continuously off-site, on the basis of detailed monthly supervisory reports. In particular, the information contained in the Central Credit Register includes the exposure of each bank to each individual firm: this enables us to assess the consistency of the different banks’ classifications of the same borrower, checking that non-performing debtors are not classified as performing by some intermediaries. Moreover, the Bank of Italy monitors the adequacy of loan classification criteria through extensive on-site inspections, among other things in order to curb the forbearance risk typical of economic slowdowns. In the second half of last year, against the backdrop of an exceptional and largely unanticipated macroeconomic deterioration, the Bank of Italy launched an ad hoc supervisory review of the adequacy of banks’ NPL provisioning policies. This involved simultaneous on-site inspections at 20 large and medium-sized banking groups whose coverage ratios either were lower than average or had fallen significantly. The main findings were published in a note posted on our website. Overall, the coverage ratio for the entire NPL portfolio of the 20 groups rose from 41 to 43 per cent between June and December 2012, notwithstanding the sharp rise in NPLs themselves (the denominator of the ratio) in the same period. In other words, the downward trend in coverage ratios since the beginning of the crisis (2007–08) has come to a halt. The intelligence gathered in the course of the review will also be used for the application of second-pillar capital add-ons. Our supervisory action continues. We are closely monitoring the implementation of the corrective measures that the banks were asked to adopt, while assessment of banks’ asset quality and provisioning levels is still ongoing and has been extended to other banking groups in the course of regular on-site inspections. Any capital shortfalls that may emerge will have to be met through proper actions within the banks’ perimeter of decisions and with recourse to the market. At the same time, we are taking care to minimize the pro-cyclical impact of banks’ actions on the availability of credit to the economy. This is why we have called on banks to increase their internally generated resources by curbing operating costs as well as dividends and executive and directors’ compensation. Our current assessment is that notwithstanding specific difficulties, the challenge will be met and market concerns will abate. But the state of the banking system is not independent of the general economic environment. Action to revitalize the Italian economy and raise its growth potential is thus as important as ever. The move to the SSM must not blur our focus on the conditions of the banking system. Supervisory standards and practices must be kept at the highest level of quality. This will permit us to perform a homogenous and comprehensive assessment of euro-area banks, with full disclosure of differences in business models but also with a common mandate to build on existing strengths and to counter and shrink the areas of weakness. The crisis has constituted a fierce challenge for the European construction. The threat of a break-up of the euro, never taken seriously by the markets before, increasingly distorted asset prices across the euro area. The economic and social costs have been severe. Unemployment, especially youth unemployment, has soared. In the worst-hit countries poverty levels have risen sharply, and social tensions have surfaced. The responsible reaction of national and European authorities has averted the worst. The recovery is now at hand, but downside risks remain significant. If we are to seize the opportunity, we cannot relax our efforts. Ultimately, our economies must restructure to become more competitive in order to rise to the challenges of technological, demographic and geopolitical change. We must press on with structural reform. The key to success will be BIS central bankers’ speeches a shared determination to advance towards a fully fledged European Union. In the current stage, the test of our resolve is the building of an effective Banking Union. BIS central bankers’ speeches | bank of italy | 2,013 | 9 |
Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the presentation of the Rosselli Foundation's 18th Report on the Italian Financial System, Rome, 7 October 2013. | Ignazio Visco: Italian banks and single European supervision Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the presentation of the Rosselli Foundation’s 18th Report on the Italian Financial System, Rome, 7 October 2013. * * * Six years of financial crisis, first global and then of sovereign debts in the euro area, and two recessions have dealt a severe blow to the euro area and Italian economies. In 2012, GDP in the euro area was still 1.3 per cent less than in 2007. In Italy, where the recession has been more protracted and deeper than in the bulk of the other member countries, it was almost 7 per cent lower. In the first half of 2013 Italy’s output continued to decline, albeit at a slower pace, thanks above all to the stimulus provided by exports. The latest indicators point to a gradual recovery, but much uncertainty remains. Any residual doubts must be dispelled as regards our ability to continue down the arduous path of reform begun in the last two years, to return to stable growth, and to guarantee balanced public accounts. The widening of yield spreads between government bonds in the euro area, the most obvious sign of the sovereign debt crisis, reflects two factors: one national and one European. These are, respectively, the weaknesses of countries’ economies and public finances (sustainability risk) and the incompleteness of the European construction and the attendant fears of a break-up of the monetary union (redenomination risk). The tensions have been tackled on these two fronts. On the one hand, countries in difficulty have pledged to adopt prudent budgetary policies and structural reforms to support competitiveness. On the other, a far-reaching reform of EU economic governance has been undertaken which, while taking shape in emergency conditions along lines that were not always clear and consistent, has nevertheless made significant progress. The strengthening of the budgetary rules, above all as regards prevention, and the extension of multilateral supervision to macroeconomic imbalances have accompanied the establishment of mechanisms for managing sovereign debt crises and paved the way for launching the banking union, resuming discussions on the budgetary union and, in the future, planning a political one. The exceptional measures adopted by the Governing Council of the ECB prevented this strategy, whose implementation will necessarily take a long time, from being compromised by the malfunctions and distortions which in the meantime have continued to affect financial and credit markets, hindering the correct transmission of monetary policy. The three-year refinancing operations approved at the end of 2011 were especially decisive, as was the announcement in the summer of 2012 of new methods of intervention on the secondary market for government securities, Outright Monetary Transactions (OMTs). Thanks to the measures taken both at national and European level, financial conditions in the euro area today are much less strained than they were at the end of 2011, when the yield spread between ten-year BTPs and the equivalent German Bunds had reached 550 basis points, or even with respect to the summer of 2012, when that same differential, after previously narrowing, had regained similarly high levels. However, a full return to normality is still a long way off. Although the segmentation of financial markets along national borders has eased, it remains marked. To restore lasting financial stability and more favourable funding conditions in the countries most exposed to the tensions, it is vital to break the vicious circle between the conditions of sovereign issuers and those of banks. Resolute progress must be made on the completion of the European Union as set out in the reports presented last year by the European Commission and the President of the European Council (jointly with the Presidents of the European Commission, the Eurogroup and the ECB). BIS central bankers’ speeches The Banking Union Banking Union is a crucial milestone. It has three components: a single supervisory mechanism, a single crisis resolution mechanism and, with a view to budgetary union, a single deposit insurance scheme. Priority has been given to the construction of the first component, the Single Supervisory Mechanism, comprising the ECB and the national supervisory authorities. Its launch is scheduled for autumn 2014, one year after the entry into force of the regulation already approved by the European Parliament on 12 September and now before the EU Council. This is a far-reaching institutional innovation which will require an organizational adaptation at least as complex as the one needed to introduce the single currency; work is continuing apace. The ECB will supervise the largest banks, assisted by the national supervisory authorities, which in turn will remain responsible for supervising the other banks in accordance with guidelines set by the ECB. Building on the technical experience of the national authorities, the single supervisory mechanism will be charged with upholding a supranational vision drawing on the best practices in supervision, analysis and assessment of banking risks, enabling easier comparison between the intermediaries and systems of the various countries, and facilitating the control and attenuation of systemic risks. The transition to a single supervisor will accordingly provide stability to the euro area, helping to improve the monetary policy transmission mechanism and curtail the trend towards financial market segmentation. The preparations for the launch of the single resolution mechanism and single deposit insurance must now be stepped up. Both are indispensable for aligning the supervisory responsibilities with those for the management and resolution of crises, and for breaking the perverse feedback loop between banks and sovereigns. In July the European Commission proposed a regulation to introduce a single banking resolution authority, drawing on common financial resources. A directive on the constitution of a European network of national deposit guarantee schemes has also been under discussion for some time. The ECB will soon undertake a comprehensive assessment of banks’ conditions prior to the launch of the single supervisory mechanism. This will be followed by an assessment of the risk profile of all the intermediaries which will be subject to centralized supervision. There will be balance-sheet assessments of all the banks, including an asset quality review and stress test. Other relevant aspects of banks’ business will also be examined, including leverage, governance and, more generally, organization. This is an especially delicate stage in the management of the crisis in the euro area and in the process of building a more complete Union. The exercise is designed to ensure that banks are managed in a sound and prudent manner and to dispel any market concerns over their financial soundness. It must be rigorously designed in order to boost the credibility of the single supervisory mechanism and foster mutual trust among the participating countries. To this end it must ensure equal treatment of all the banks, which are currently subject to supervisory systems based on very different national accounting and supervisory practices; examples include differences in the definition and measurement of impaired loans, risk-weighted assets, off-balance-sheet items and “level 3” assets (very illiquid assets whose fair value is estimated through internal bank models). In all of these areas at least de facto harmonization towards the best and most rigorous practices must be attained before the assessment can begin; the credibility of the entire exercise depends on it. The European Banking Authority is working on the harmonization of the definition of impaired loans and has recently published a consultation document. It is a step in the right direction. The methodologies employed must be fully transparent. The findings should be published together with all the information that the market needs for a comprehensive assessment. The contribution of external experts, provided that care is taken to avoid conflicts of interest, will improve the credibility of the exercise. BIS central bankers’ speeches The assessment must embrace all types of risk, bearing in mind the existing prudential rules. The markets should be given reassurance that a proper evaluation will also be made of those risks which, by virtue of the underlying instruments and the method of computing the related capital requirements, are noted for their extreme opacity. In the case of sovereign risk, there is no denying that its perception by the markets continues to be influenced today by fears – unfounded, in our opinion – concerning the euro’s resilience. It would be a mistake to base any assessment of the riskiness of sovereign exposures on this perception, thereby implicitly sharing it. Banking union is part of a broader strategy aimed at reassuring the markets about the irreversibility of the euro, and the assessment exercise is key to achieving this objective; we cannot risk fuelling the very fears we wish to dispel. At the same time there must be full transparency regarding the composition of banks’ assets. Any capital shortfalls will have to be met by first drawing on banks’ own funds, not distributing dividends, disposing of non-strategic assets, and cutting back on all cost items, including executive pay. When necessary, additional funds should be raised on the market. National plans should, in any event, be drawn up to cope with the eventuality of residual recapitalization requirements, given the decision that the European Stability Mechanism (ESM) will only be able to intervene directly when the Single Supervisory Mechanism becomes fully operational. In the meantime, the ESM’s resources can be used indirectly, in the form of loans to member states; these would nonetheless weigh on their public debt, threatening to rekindle the vicious circle between sovereign risk and bank credit conditions. The Italian banking system Factors such as the weakness of the economy, uncertainty regarding the depth and strength of the recovery, and the still fragile state of the financial markets are forcing Italian banks to continue down the road of monitoring liquidity and credit risks, strengthening capital and reigning in costs. The increased availability of assets eligible as collateral in Eurosystem refinancing operations has improved the banks’ liquidity position, allowing them to cope with the large volume of bonds due to mature in the coming months. However, these assets include government-backed own use securities maturing over the next few years. For the future, the availability of collateral must be ensured by extending the range of eligible credits, including to new categories; special care must be taken to ensure that the methods of granting the loans comply with the requirements for Eurosystem refinancing. The amount of collateral must also be sufficient to withstand a possible depreciation of the eligible assets caused by a sovereign downgrade. In any event, recourse to central bank financing cannot be the only answer; efforts to regain access to the markets must continue. The banks’ exposure to Italian government securities has increased considerably since the beginning of last year. Contributory factors have been the sharp drop in the returns on (riskadjusted) investment and the relatively high yields on government securities, set against the need to temporarily invest the liquid assets obtained from the two three-year Eurosystem refinancing operations. The recovery of the economy and a return to normal conditions on the credit market will allow banks to adopt asset allocation policies that enable them to provide greater lending support to households and businesses. Renewed confidence on the part of domestic and foreign investors, along with balanced public accounts and pro-growth reforms, will pave the way, without tensions developing on the market for government securities. Lending continues to perform poorly as a result of the unfavourable economic situation, which is dampening demand and conditioning supply because of the adverse selection risks stemming from the deterioration in borrowers’ creditworthiness. In the second quarter of this year, the ratio of the flow of new bad debts to outstanding loans, on an annual basis, reached 2.9 per cent; the increase affected only businesses. In June this year, impaired loans (which include not only bad debts, but also non-performing, restructured and past-due loans) BIS central bankers’ speeches amounted to €300 billion gross. Net of the value adjustments already made, this figure drops to around €190 billion, of which just over €70 billion are in bad debts, now amply covered at system-wide level by collateral and personal guarantees. Gross impaired loans represent 14.7 per cent of total lending, falling to 9.6 per cent after value adjustments. In the first half of the year, losses on loans absorbed three quarters of operating income. The banking system’s difficulties are unlikely to be overcome soon. There is still pressure to reduce the size of banks’ balance sheets. However, these developments may provide the right incentives to Italian firms to overcome their heavy reliance on bank credit. The business sector needs to find other means of financing investment. On the other hand, it is in the banks’ interest to keep a balance between loans and deposits, and to share with the markets the risks of lending to customers. Helping businesses access the capital markets is not an easy task for the banks, requiring the ability to assess firms’ economic and financial prospects; care must be taken to avoid potential conflicts of interest. Our supervision, conducted both off-site and on-site, reflects our concern for the trends in lending and credit quality. Its purpose is to make sure, in particular, that impaired loan coverage ratios are adequate, and are increased whenever necessary. Far from damaging the banks, it helps to strengthen them, reassuring the markets as to the quality of their assets. The findings of the inspections carried out between the end of 2012 and the early months of this year are set out in a report published on our website. We are verifying that the corrective measures, including organizational ones, which the banks were asked to take have been promptly put in place. Meanwhile, work to verify the adequacy of coverage ratios continues, in some cases also taking in the whole credit portfolio. The opinion, voiced repeatedly during the crisis, that Italy’s banking system stands in dire need of recapitalization is unfounded. Only a few days ago the International Monetary Fund published the results of its periodic Financial Sector Assessment Program for Italy. It acknowledges that the Italian banking system has managed, overall, to weather the doubledip recession and the sovereign debt tensions, extending its solid deposit base and strengthening its capital. Unlike other countries, it has succeeded, notwithstanding the difficult conditions, in raising additional funds almost entirely on the capital market, without burdening public finances and heightening sovereign risk. The banking system’s resilience was aided by a model of supervision, regarded by the IMF as a pillar of financial stability, which adheres closely to established international standards and is based on intense and strict oversight. The IMF also recommended that steps be taken to improve the effectiveness of supervision in some specific areas: transactions with related parties, the requirement for shareholders and corporate officers to act honourably and professionally, and the power to impose corrective measures such as the removal of company directors and executives. The crisis management and resolution system has been effective, making it possible to address the effects of the crisis without affecting the stability of the system. The IMF’s recommendations, aimed at further strengthening the system, are in line with the proposed European Bank Recovery and Resolution Directive, to be approved in the coming months. We will make sure that the IMF’s recommendations are put into practice. To evaluate the banking system’s capacity to withstand adverse macroeconomic scenarios, the IMF conducted the usual series of stress tests. These were based on the situation of banks’ balance sheets at end-2012, which had already incorporated the results of our own supervisory action on the adequacy of impaired loan coverage. The IMF evaluated the impact of macroeconomic scenarios over three or five-year time horizons. The results, in line with those of similar tests conducted by the Bank of Italy, show, first of all, that the system can cope with a weak macroeconomic situation over the coming years as BIS central bankers’ speeches hypothesized in the baseline scenario and, at the same time, will be able to accommodate the gradual entry into force of the Basel III capital requirements. Thanks in part to the capital strengthening achieved over the last few years, the overall system should now be able to weather a more adverse scenario, one in which GDP growth in the three years 2013–15 is cumulatively more than 4 percentage points lower than in the baseline scenario. In this case, the amount of additional capital which some banks would need to raise in order to meet the minimum regulatory requirement would not be large. Depending on the definition of capital used, the IMF estimates that total capital requirements would be between €6 billion and €14 billion and, in any event, less than 1 per cent of GDP. It is worth recalling that these are hypothetical capital requirements, which would result from a very unlikely scenario, although not an extreme one. In addition, they are based on the hypothesis that over the time horizon covered by the tests, the banks do not independently strengthen their capital position, which some of them will need to do anyway with a view to their balance-sheet assessment. The difficulties mainly concern medium-sized and small banks, which are particularly affected by macroeconomic developments, including those at a local level, or whose governance structures make it hard for them to implement capital-strengthening measures. These are mostly cooperative banks or banks in which a foundation holds at least 20 per cent of the capital. Last June the core tier 1 ratio of these two categories of banks was 9.5 and 9.2 per cent respectively, against 11.4 per cent for the other intermediaries set up in the form of limited liability companies. On several occasions I have underlined the importance of corporate governance profiles in ensuring an informed assumption of risks, correctly allocating credit to the economy, managing conflicts of interest, and facilitating capital strengthening. In the light of the forthcoming Banking Union as well, the necessary interventions can no longer be put off. The review of cooperative banks’ governance should encourage new shareholders to inject capital and to increase the control over management through less subdivision of shareholdings. For large cooperative banks with many and wide-reaching business activities, the most suitable legal structure is that of a limited liability company. Banking foundations must diversify their portfolios to limit their reliance on the performance of investee banks. Above all, they must not interfere in the banks’ governance or management decisions. The composition of their management bodies, often too numerous, must be streamlined to make individual directors responsible, ensure that the collegial bodies function well and eliminate unnecessary costs. The strengthening of Italy’s banking system must include a return to profitability. Compared with the pre-crisis period, when it stood at around 60 per cent, the cost-income ratio has not decreased. Last June it averaged 62 per cent for the top five banking groups. This can be attributed to a fall in earnings, in turn affected by the lack of diversified sources of income. In the present situation it is hard to imagine a significant increase in bank income, in view of the performance of lending, reduced margin rates and low demand for asset management products. In the short term the recovery of profitability will require incisive action on the cost front, including labour costs. This will entail a thorough review of the combination of factors of production and of the structure of distribution channels. Remote channels will handle the distribution of highly standardized products and products with low added value; the size of the traditional distribution network will be reduced, freeing up resources to develop the remaining branches, which should concentrate on the more complex products. Italian banks, besides issuing loans, often own shares in companies. In some cases these links have distorted lending decisions, giving rise to collusion or attempts to delay the emergence of difficulties. On previous occasions I have stressed that these risks, like all those deriving from relationships with entities closely connected to the banks, must be properly monitored by the management bodies. The Bank of Italy will continue its supervision and will require any shortcomings to be rectified. BIS central bankers’ speeches Concluding remarks Economic activity in the euro area is on the path to recovery, but the pace is slow and differs from country to country. In Italy, as in other euro-area economies, conditions remain difficult, despite some signs of stabilization. The timing and strength of the recovery will depend not only on continuous and effective reform but also on the availability of sufficient financial support for businesses. Decisive progress towards the completion of the European Union could halt the downward spiral caused by the strains on sovereign borrowers and on financial intermediaries, encouraging a return to more favourable credit conditions. The Banking Union is the first important step towards a budgetary, and ultimately a political, union through a process that should not be taken as purely sequential: on the one hand, the pooling of national resources is necessary to complete the Banking Union but, on the other, strong signals of political union would counter the perception of reversibility risk for the single currency. It is a delicate passage, to be undertaken with rigour and responsibility, avoiding errors which could rekindle tensions on the financial markets. The Italian banking system is moving along this path, beset by structural problems and weakened by the long recession. But the system can count, partly thanks to the work of the Bank of Italy, on strengthened capital and prudent evaluations of the quality of its assets. There is no immediate, simple solution that will allow the banks to fully resume their role of supporting economic activity. They must continue to work towards restoring profitability and strengthening capital, as well as adapting their corporate strategies to the changed technological and market conditions. Today, the banks are also being called upon to rapidly change pace. BIS central bankers’ speeches | bank of italy | 2,013 | 10 |
Lecture by Mr Ignazio Visco, Governor of the Bank of Italy, at Harvard Kennedy School, Cambridge (USA), 16 October 2013. | Ignazio Visco: The aftermath of the crisis – regulation, supervision and the role of central banks Lecture by Mr Ignazio Visco, Governor of the Bank of Italy, at Harvard Kennedy School, Cambridge (USA), 16 October 2013. * * * Previous versions of this text were used for lectures at the Imperial College in London and at the Accademia dei Lincei in Rome in March 2013. I wish to thank for useful discussions and help Fabrizio Balassone, Paolo Del Giovane, Alessio De Vincenzo and Giuseppe Grande. Introduction The financial crisis has brought to the fore a number of issues. It has been severe and widespread, and has affected many economies in different and long-lasting ways. Maintaining financial stability has once again become a major concern of policy makers; central banks are being heavily involved in this endeavour. A clear need has emerged for a substantial overhaul in financial regulation and supervision, also considering that the financial system of tomorrow will most likely be rather different from the one that has developed over the last two decades. Scepticism has grown about the role of finance in the economic system, and especially its apparent separation from, if not conflict with, the real economy. We should take stock of what has gone wrong, and in so doing reflect on the way forward, as it is already taking shape, as well as on how to better link our theories to real world developments. In the decade before the crisis both the size of the financial system and its role and pervasiveness in the economy increased dramatically. The process has only slowed down with the crisis. In the euro area, the overall amount of financial resources collected by the private sector (bank credit, bonds issued domestically and stock market capitalization) rose from 140 per cent of GDP in 1996 to 210 in 2007, to further increase to 240 in 2012. Broadly similar patterns are found for the United States, where the ratio rose from 230 per cent in 1996 to 360 in 2007 and then declined to 310 in 2012, and for the UK, where the ratio increased from 280 to 440 per cent and then remained stable. The total outstanding notional amount of over-the-counter (OTC) and exchange-traded derivatives has risen from less than 100 trillion US dollars at the end of 1998 to around 500 trillion at the end of 2006, 700 at the end of 2007 and still 700 trillion in December 2012. Financial deepening, by allowing greater diversification of risk and making finance accessible to larger numbers of countries and firms, can be instrumental to broadening economic development. But there is a risk that finance turns into an end in itself, with consequences that can be more damaging as the system becomes more interconnected and the potential for externalities increases. At the same time, the interaction between monetary policy and financial stability becomes more relevant as heightened financial complexity amplifies the widespread non-linearities in the dynamics of financial and economic variables and the consequences of interconnections between the financial and the real side of the economy. In these conditions, the risk of systemic crises increases. The correct conduct of financial business requires competence and good faith on the part of intermediaries, as well as appropriate regulatory, supervisory and policy regimes. The fact that fragilities in the financial system were not properly and timely identified, and that their potential consequences for macroeconomic and price stability were largely underestimated reflects inadequacies in regulation and supervision, as well as in the analytical framework for monetary policy. BIS central bankers’ speeches The financial crisis has provided two main lessons for policy-makers: first, complexity is not a justification for a light-touch approach to regulation and supervision, quite the contrary; second, financial stability is a precondition for price stability. Two implications, then, have followed suit: on the one hand, a deep and far-reaching reform in financial regulation and supervision was needed (including tighter international cooperation), on the other hand, central banks had to rethink their role and the tools of their trade, specifically concerning the relationship between monetary and macroprudential policies. “Good” finance as a force for good Finance has long been viewed as a morally dubious activity. My appeal to authority on this matter is a reference to a lecture delivered by Amartya Sen more than twenty years ago as the first Paolo Baffi Lecture on Money and Finance at the Banca d’Italia. Sen wondered: “How is it possible that an activity that is so useful has been viewed as being morally so dubious?”.1 He recalled a series of historical episodes: Jesus driving the money lenders out of the temple, Solon cancelling debts and prohibiting many types of lending in ancient Greece, Aristotle describing interest as an unnatural and unjustified breeding of money from money. Superimposed on this “structural” mistrust, one can detect cyclical patterns in the public’s attitude towards finance, affected by the conditions of financial systems and shifts in the political mood about state intervention in the economy. Until the 1970s it was taken for granted that market failures required the presence and response of a regulator to avoid suboptimal results. Then came the great inflation of the 1970s, combined with high unemployment, and the emphasis shifted to government failures. Governments, central banks and other regulators were blamed for failing to prevent these developments. This eventually led to an ideological swing: a push to reduce the extent of state intervention. The failures of the “regulated economy,” the pace of technological advance and the rapid expansion of international trade after the end of the Cold War fuelled a protracted process of financial deregulation that was halted only by the financial crisis that broke out in 2007. The latter triggered a move toward re-regulation – or better regulation – that is still under way. The pendulum keeps swinging and will certainly continue to do so. The global financial crisis, with its huge costs for the whole society, has caused a further deep erosion of the trust in financial institutions. Witness to this are the widespread protests against the financial industry, from the Occupy Wall Street movement to the “Indignados” in Spain and their counterparts in other European countries. Anger has been fuelled not only by the discovery of wrongdoings and perverse incentives, but also by a perceived lack of action against those responsible, in a context of exceptionally high remunerations. The integrity of financial intermediaries’ codes of conduct has been called into question under many dimensions: honesty, the ability to manage financial risks and the commitment to take care of the interests of their clients. In the first place, public attention was caught by cases of investment fraud, in which Ponzi schemes or other types of malpractice and malfeasance led many people to lose their savings. Feelings were exacerbated by the generous severance packages paid to top managers after distressed financial institutions were rescued with taxpayer money. Dubious practices were found in key junctures of the financial systems, such as credit ratings and interbank reference rates, not to mention the allegations of financial institutions’ involvement in activities related to money laundering and other fraudulent practices. Most importantly, the crisis has shown that market participants were not capable of mastering the inherent complexity of the system that they themselves had contributed to A. Sen, Money and value: on the ethics and economics of finance, Paolo Baffi Lecture on Money and Finance, Rome, Bank of Italy, 1991, p. 28. BIS central bankers’ speeches develop over the course of the last two decades. Favoured by the breakthroughs in information technology and telecommunications, the securitization of banks’ assets expanded considerably, together with the supply of so-called structured financial instruments (ABSs, CDOs, etc.). The traditional model of credit intermediation gave way, especially but not only in the United States, to a system in which loans granted were rapidly transformed into other financial products having these loans as collateral and sold on the market: the socalled originate-to-distribute model (OTD). To the inherent difficulty of evaluating the quality of loans, these developments added the problem of fully understanding the role of structured finance products. Structured finance products and the OTD intermediation model can facilitate risk management. The granting of mortgages to households is favoured by the possibility of managing the related interest-rate risk; the internationalization of firms depends crucially on the possibility of hedging foreign exchange risk; and the provision of retirement saving products at low cost over very long time horizons benefits from the ability to mitigate the impact of fluctuations in security prices. With the OTD model, credit risk is not concentrated in the banks’ books, but is potentially dispersed among a multitude of investors. By making bank loans tradable, it reduces their illiquidity premium thus decreasing their cost. However, we now understand that structured finance and OTD intermediation, coupled with lack of transparency, favoured excessive risk taking and opportunistic behaviour. Transactions often took place through scarcely regulated financial intermediaries characterized by high leverage and risk exposure, whose valuation (in which a crucial role was played by rating agencies, without any particular control by regulatory authorities or information providers) was carried out by means of statistical models and often on the basis of incomplete and insufficient data. In many instances complexity was instrumental to opportunistic behaviour fuelled by a distorted system of incentives especially with reference to executive compensation. The high leverage and complexity typical of structured financial instruments allowed them to be used to take high-risk, speculative positions. Unnecessarily complex and opaque assets were used to prevent a correct assessment of creditworthiness or mask the economic impact of previous transactions, exploiting the ample scope for interpretation allowed by accounting standards. Banks’ misuse of these instruments may also be linked to the drying-up of the sources of income from traditional credit business. This may have triggered actions designed to conceal from the market and from supervisors the real object of derivatives transactions. The bottom line is that financial innovation can allow more efficient allocation of credit risk, but it also entails a number of dangers, some of them intrinsic to its mechanism, others more generally related to the greater interdependence of the financial system. The process of financial consolidation and the OTD model have produced intermediaries that are closely intertwined with the capital markets. This has had some important consequences for financial stability: a more connected world improves risk diversification and can make markets more resilient, but when contagion is actually set off, an interlinked financial system heightens the risk that it may spread more widely. But the negative perception of banking and finance should not lead to a blind backlash. As Amartya Sen argued, “finance plays an important part in the prosperity and well-being of nations”.2 It is crucial for sharing and allocating risk, especially for poorer societies and people, insofar as risk aversion decreases with wealth. It is crucial for transferring resources over time and removing the liquidity constraints that hamper the economy and the exploitation of ideas. It is very important in promoting economic growth, especially by fostering innovation. A. Sen, ibidem, p. 28. BIS central bankers’ speeches Indeed, we have countless historical examples of good financial innovations. Think, for example, of the “letters of exchange” introduced by Italian merchants in the Middle Ages: they were probably the first fiduciary money, and trade benefited enormously from this financial instrument. More recently, consider the development of “micro-finance” in the 1970s: an innovation that has enhanced financial inclusion, helping poor borrowers to smooth their income and cope with illness or other temporary shocks. And, in the last decades of the past century, recall the role of the “venture capital” industry in the promotion of successful innovative corporations such as Apple, Google or Intel. Some countries are now increasingly investing in efforts to improve the financial literacy of the public, and this too is important. On the one hand, it helps to build the demand side of a more inclusive finance. On the other, financially literate citizens are better able to understand the efforts of regulators and policy makers to improve supervision and regulation, and less likely to subscribe to the simplistic view that “finance is evil”. But we should realise that – as the case of Bernard Madoff and others in the US and elsewhere clearly show – this is no panacea (Madoff’s customers were surely much better educated than average). Therefore, for purposes of consumer protection in the financial services industry, regulation and good supervision are the necessary complements to education and inclusion. Complexity was used, somewhat perversely, as an argument in favour of a sort of benign neglect on the part of regulators. The big financial players argued successfully that innovation was too complex and too opaque for the regulators to get their heads around. Indeed, they said, to safeguard the international financial system from systemic risk, the main priority was promoting an “industry-led” effort to improve internal risk management and related systems. This, in a nutshell, was the view espoused by the Group of Thirty report following the outbreak of the Asian crisis.3 But this thesis was often accompanied by the argument to the effect that “you, regulators and supervisors, will always be behind financial innovation; it would be better to allow us, the big financial international players, to selfregulate; we are grown-ups, we can take care of ourselves”. And, after all, “if someone makes mistakes some will gain what others lose; why can’t we be left alone to play this zerosum game of ours?” The regulators did not, in fact, have either the ability, or the right incentives to acquire the necessary information to deal with complexity, for two reasons. First, the big financial players are global, and national regulators had powers too narrow to be able to confront them. The difficulties in coordinating the regulators’ actions, in the face of a natural tendency to preserve each one’s particular sphere of influence, was a powerful drag on the ability to rise to the challenge posed by a finance gone global. Second, the phenomenon of regulatory capture was a definite reality. Powerful political and economic influences were at play, and in some cases prevailed. Accepting the idea that benign neglect was the right course of action was, however, a critical mistake. The global financial crisis has highlighted the limits of the idea that self-regulation and market discipline are sufficient to ensure stable financial systems. Regulation and supervision have to keep pace with developments in the industry. National authorities need to be aware of the risk that their powers become narrow compared to the sphere of influence of the global players; the coordination of supervision across borders and across sectors is a key condition for the stability of the global financial system. More importantly, regulators and supervisors have to pay attention to keeping industry lobbies at due distance. To a significant extent, the recent crisis also owes to insufficient market discipline (including the role played by credit rating agencies), which failed to reign in (or even counter) in a timely Group of Thirty, Global institutions, national supervision and systemic risk, 1997. See also the article by J. Heimann, with the same title, and comments therein, in the special issue of Banca Nazionale del Lavoro Quarterly Review on “Globalization and stable financial markets”, March 1998. BIS central bankers’ speeches way imprudent behaviour, excessive leverage, or over-borrowing on the part of financial intermediaries (and sovereigns as well). At the same time, monetary policy overlooked the risks for price stability coming from the financial sector. The idea that it is optimal to “mop-up” after a bubble has burst rather than implementing “leaning against the wind” policies, which seemed to have passed the test of the dot-com bubble, led to a long period of excessive monetary accommodation. It has now indeed become clear that financial stability is a precondition for price stability and that the “mop-up” approach is not always the best strategy. Notwithstanding huge monetary and fiscal interventions, six years after the burst of the credit-fuelled housing bubble most advanced economies are not yet back on stable growth trajectories. A key lesson of the last decade, also supported by an increasing number of theoretical and empirical analyses, is that too low for too long interest rates can stimulate risk taking and sow the seeds for the next crisis if left unchecked by regulators and markets alike. All this called for a major effort, at a national but especially at an international level, to adjust and strengthen the regulatory and supervisory financial framework. It has also suggested that central banks should rethink their role and their instruments. This I will attempt to review and assess in what follows. I will also briefly discuss the importance of advances in our analytical understanding of the workings of financial markets and of its deviations from the stationarity assumption. In search of a better regulatory and supervisory regime Over the last few years the crisis has heightened appreciation of the benefits of a more stringent regulatory regime. At an international level, under the political impulse of the G-20, the Financial Stability Board (FSB) and the Basel Committee on Banking Supervision (BCBS) have introduced substantial regulatory changes to reduce the frequency of financial crises and increase the resilience of economic systems. Much has been achieved. The quantity and quality of capital that banks need to hold has been significantly enhanced to ensure that they operate on a safe and sound basis. Minimum capital requirements have been raised. The improvement in the quality of capital aims to ensure that banks are better able to absorb losses on both a going concern and a gone concern basis. The risk coverage has been increased, in particular for trading activities, securitisations and exposures related to off-balance sheet vehicles and arising from derivatives. An internationally harmonised minimum leverage ratio is going to be introduced, to serve as a backstop to the risk-based capital measure and to contain the build-up of excessive leverage in the system. The BCBS has also introduced international standards for bank liquidity and funding, designed to promote the resilience of banks to liquidity shocks. A minimum requirement for the ratio between high quality liquid assets and net liquidity outflows that banks would face over a one-month horizon in stress conditions (Liquidity Coverage Ratio – LCR) will soon be adopted. The minimum LCR will increase gradually in the coming years, so as to ensure that the new liquidity standard will not hinder the ability of the global banking system to finance the recovery. At the behest of the G-20, the FSB has promoted initiatives to strengthen the regulation of the OTC derivatives market. The aim is to reinforce market infrastructures, in order to minimise contagion and spill-over effects among players that have become more and more interconnected. These initiatives will increase transparency through requirements to trade on organised platforms and to report transactions to trade repositories. They will also reduce and allow more systematic control of cross-exposures between financial firms in this market, by ensuring that central counterparties are placed between the two participants in standardised transactions and by setting minimum capital and margining requirements. But further progress is needed in important areas. Work should focus on internal risk control arrangements and disincentives to excessive risk-taking, on the rapid implementation of the BIS central bankers’ speeches set of policies developed to address systemic risks from shadow banking, on reducing market participants’ mechanistic reliance on credit rating agencies, on increasing transparency, including by completing international convergence of accounting standards. Board members and senior managers should possess a thorough understanding of the financial firms’ overall operational structure and risks. It is also fundamental that supervisors regularly assess banks’ corporate governance policies and practices. Compensation policies need to be revised, in order to better align remuneration with risk-adjusted long-term performance and avoid excessive risk-taking and short-termism. In particular, when designing compensation policies, banks should take into account a number of issues: the variable portion of the compensation of risk takers must be paid on the basis of individual, business-unit and firm-wide measures that adequately assess risk-adjusted performance; bonuses must reward the achievement of stable earnings, not simply the fruit of extraordinary operations; executives’ severance packages too must be clearly and effectively bound to the results attained, and reflect a more general evaluation of the manager’s performance; compensation must be deferred long enough to validate the true quality of management. The debate that has started with the so-called Volcker rule on the organizational structure of banks and the need to separate traditional credit business from activity in the financial field has been reinvigorated at a European level by the reports of the Vickers Commission in the United Kingdom and the Liikanen Group for the whole European Union. Both the Volcker rule and these reports call for a much needed discussion around business size and complexity in the financial sector; the experience of the crisis has indeed shown that we should not be shy to thoroughly re-assess relative merits and costs of both (size and complexity). These reports trace out possible lines of intervention. Protecting retail deposits and taxpayers’ money from the risks implicit in trading activities (what used to be called “speculation”) – the rationale behind these proposals – is crucial. The experience of the crisis has shown that, even if no specific business model has performed particularly well or poorly, the banks’ organizational structure has an impact on the propensity of managers to engage in excessively risky activities. At all events, in today’s globalized world it is crucial to make sure that countries cooperate and agree on the appropriate stringency of financial regulation. Countries should not compete by relaxing rules in order to attract financial business, as this generates negative externalities for other countries. This is a most delicate issue, and while a perfectly level playing field may not be achievable, we have to be conscious of the consequences of a “beggar-thy-neighbour” approach to regulation. The transition to a uniform system of rules and oversight of the financial sector must be hastened. In the euro area the plan for a banking union is ambitious; it goes in the right direction. Some progress has been made on the convergence towards a single set of global accounting standards; but much remains to be done. The International Accounting Standards Board and the US Financial Accounting Standards Board expect to make progress on the two key outstanding issues of impairment of loans, where their deliberations should be completed in the next months, and insurance contracts, where both Boards are holding public consultations. Of these two outstanding issues, the need for convergence on a new forward-looking expected loss approach to provisioning is of most immediate concern for end-users and from a financial stability perspective. One element that is essential for guaranteeing systemic stability is the method of measuring risk-weighted assets (RWA), the denominator of capital adequacy ratios. RWA measures have recently attracted increasing attention from market analysts, banks and supervisory authorities. It has been argued – and this seems to be actually the case – that the methodologies for computing RWAs may not be comparable across institutions and, especially, across jurisdictions, and that they should more properly reflect risk in order to avoid ultimately jeopardising financial stability. These problems highlight the relevance of BIS central bankers’ speeches supervisory practices in determining banks’ capital requirements (for example, in validating internal banks’ models for calculating risk weights). Here, rigorous micro-prudential supervision is essential. We really need to work out a single rulebook, to move with determination towards taking joint responsibility and using peer reviews as much as possible in our supervisory activity. Overcoming differences in accounting and supervisory practices is proving a major challenge on the way to the banking union in the euro area. As for the initiatives to strengthen the regulation of the OTC derivatives market, these complex reforms are taking somewhat longer than originally planned. It is therefore necessary to pick up the pace, overcoming the difficulties of implementation and the industry’s resistance. Authorities must make all efforts to remove the uncertainties arising when transactions involve a cross-border dimension, which is a recurrent condition in a global market. This is necessary to pre-empt regulatory arbitrage and, ultimately, to achieve the G20 objectives. Work is also in progress on other relevant issues at an international level (capital requirements for exposures to central counterparties, margining standards for noncentrally cleared transactions, as well as on authorities’ access to trade repository data) and at a regional and national level. It will be crucial to ensure that stricter regulation and supervision of banks will not push banklike activities and risks towards non – or less – regulated institutions (the so-called “shadow banking” sector). Let us not forget that the financial crisis originated in the US securitization market, largely populated by unregulated or scantily regulated operators. While we have to address bank-like risks to financial stability emerging from outside the regular banking system, the approach should be proportionate, focussed on those activities that are material to the system, using as a starting point those that were a source of risk during the crisis. The FSB has released a final set of recommendations in August 2013.4 One should bear in mind, however, that the new recommendations will be able to address the specific risks that arose during the crisis, and we all recognise the ability of the shadow banking sector to innovate. Although new regulations on systemically important financial institutions have recently been approved, the “too-big-to-fail” issue is still a major concern, and it merits strict monitoring. Systemically important financial institutions (SIFIs) are being identified in different sectors, and three types of measures will be applied to sharply reduce the threat that their failure poses to the wider system. First, legal and operational regimes will be changed to enable all financial institutions, including those operating across borders, to be resolved safely and without taxpayer loss if they fail. Second, requirements that SIFIs have higher loss absorption capacity will be introduced. Third, supervisory oversight (including sharing of risk data) will be stepped up to reflect the additional complexity of these institutions and the systemic risks they pose. Negative externalities associated with banks’ behaviour (especially for large, interconnected financial firms) must be taken into account. A broad consensus has emerged on the idea that “macroprudential” policies directed towards preserving financial stability should limit systemic risk by addressing both the cross-sectional dimension of the financial system, with the aim of strengthening its resilience to adverse real or financial shocks, and its temporal dimension, to contain the accumulation of risk over the business or financial cycle. Finally, even after the completion of the regulatory overhaul, it would be foolish to pretend that defaults can always be avoided. They may be the result of imprudent behaviour or of fraudulent operations. We need to be prepared for their occurrence, as the costs of public support tend to be very high. In Europe, according to the latest data gathered by the European Commission, the outstanding amount of public recapitalizations as of December 2012 came to 0.3 per cent of GDP in France, 1.8 in Germany, 5.5 in Spain, 4.2 in the UK, 4.3 in Belgium, 5.1 per cent in the Netherlands, and 40 per cent in Ireland. For Spain and http://www.financialstabilityboard.org/publications/r_130829b.pdf. BIS central bankers’ speeches Ireland these amounts are at their highest since 2008, in the other countries they are lower than the peaks reached in 2009. For the Spanish banks, a programme of recapitalization using European funds of up to €100 billion was authorized in July 2012, of which €41 billion (3.9 per cent of GDP) has already been disbursed. In Italy, taking also into consideration the additional public support provided to Banca Monte dei Paschi di Siena, public recapitalizations currently amount to 0.2 per cent of GDP. These figures indicate that the ongoing work on resolution regimes is very important in this regard, and rapid progress should definitely be made. This is particularly relevant in the euro area, where the new single supervisory mechanism (the SSM) is being implemented. Observations on the analytical implications of economic and financial instability Economic systems constantly evolve and transform. Changes in institutional arrangements, technological innovation and revisions in economic policy paradigms continuously reshape the framework in which economic agents (consumers and businesses) make their decisions. This in turn leads to changes in economic agents’ behavioural patterns. When there is marked discontinuity with the past, such changes may be far-reaching and the past fails to provide enough guidance for the present (never mind the future). We should always remember that the financial system is part of a richer social, economic and political environment. The real world is subject to shocks that at times may have dramatic consequences, such as those that we have experienced in the last twenty years or so, with the end of the cold war, globalization and the sudden emergence of new major economic actors, the ICT revolution, and substantial (not completely anticipated) demographic changes. However, a stationarity assumption of sorts underpins our theoretical and statistical models, in the case of economic forecasting and (macro) policy making as well as in the case of financial analysis and risk management. In general, the basic tenet is that future outcomes will be drawn from the same population that generated past outcomes, so that the time average of future outcomes cannot be persistently different from averages calculated from past observations, and future events can be predicted with a certain degree of statistical accuracy. In non-ergodic environments, on the contrary, at least some economic processes are such that expectations based on past probability distribution functions can differ persistently from the time averages that will be generated as the future unfolds.5 In case of acute uncertainty, no analysis of past data can provide reliable signals regarding future prospects. The challenges posed by the non-ergodic nature of economic systems may be met by recognizing that our models are by necessity “local” approximations of very complex economic and financial developments. One needs to be modest, using theory and empirical models as starting points for, not straightjackets in, our decision making. And perhaps not enough attention has been paid by the financial community to the need for establishing institutional and behavioural norms to reign on patterns of instability and developing proper learning devices to deal with major shocks and regime changes. These challenges are compounded by another general characteristic of the quantitative analysis of economic phenomena: the difficulty of running parallel worlds, i.e. producing data through experiments designed and controlled by the researcher. Even when economic forces do follow repetitive patterns, it may not be easy to spot empirical regularities, because contingencies – especially the exceptional ones – cannot be re-created at will, in the laboratory, for cognitive purposes. Our experience will always be limited, partial and episodic. These aspects are not always taken into account in economics or finance. As Charles P. Davidson, “Is probability theory relevant for uncertainty? A Post Keynesian perspective”, Journal of Economic Perspectives, 5, 1, 1991. BIS central bankers’ speeches Kindleberger noticed: “For historians each event is unique. Economics, however, maintains that forces in society and nature behave in repetitive ways”.6 Why is it that the parameters and laws governing economic systems tend to change over time? A distinction can be made between exogenous uncertainty, when an individual’s actions do not affect the probability of an event occurring, and endogenous (or behavioural) uncertainty, when they do.7 In economic systems, this second type of uncertainty can be particularly important. This has not been sufficiently recognized, I believe, in the way (applied) macroeconomics and finance have evolved since the 1980s, with the ascendency of the rational expectations revolution in the former and the efficient market hypothesis in the latter. In macroeconomics this may have led to placing too much faith in the ability of dynamic stochastic general equilibrium (DSGE) models to represent or sufficiently approximate the real world on which economic policy is applied. These fundamentally linear models are the result of the intertemporal optimization by representative agents of objective functions under conditions of uncertainty, given technological and budget constraints and the “rationality” of their expectations (i.e. perfect foresight barring a random error). Indeed, going beyond the assumption that society and nature always behave uniformly and consistently over time has deep implications in policy making as well. This can be easily seen in monetary policy, where no mechanistic use of forecasting models can be made if one allows for the possibility of structural changes.8 An important lesson of the financial crisis – one that is generating substantial research activity – is that the interactions and feedbacks between the real and the financial sectors and the non-linearities that emerge especially during crises are not adequately captured by the available models. Many of the effects associated with financial and asset price imbalances are likely to be highly non-linear and complex. The reaction of monetary policy should then also be non-linear and it should respond to asset price misalignments and financial imbalances. When the probability of a crisis becomes non-trivial, the interest rate path towards ensuring monetary stability might be different than in ordinary circumstances. These aspects were not well captured in the empirical models used to support monetary policy decisions, something understood but perhaps not adequately recognized in discussions on flexible inflation targeting frameworks that took place a decade or so ago.9 One of my preferred quotes is from Herbert Simon:10 Good predictions have two requisites that are often hard to come by. First they require either a theoretical understanding of the phenomena to be predicted, as a basis for the prediction model, or phenomena that are sufficiently regular that they can be simply extrapolated. Since the latter condition is seldom satisfied by data about human affairs (or even by the weather), our predictions will generally be only as good as our theories. The second requisite for prediction is having C. P. Kindleberger, Manias, panics and crashes: a history of financial crises, New York: Basic Books, 1989, p. 14. I. Visco, “On the role of expectations in Keynesian and today’s economics (and economies)”, Convegno Internazionale dell’Accademia Nazionale dei Lincei, “Gli economisti postkeynesiani di Cambridge e l’Italia”, Rome, 11–12 March 2009 (http://www.bancaditalia.it/interventi/intaltri_mdir/en_Visco_110309.pdf). See, among others, J. Vickers, “Inflation targeting in practice: the UK experience”, Bank of England Quarterly Bulletin, November 1998. See C. Borio and P. Lowe, “Asset prices, financial and monetary stability: exploring the nexus”, BIS Working Papers, 114, July 2002 (http://www.bis.org/publ/work114.pdf). See also C. Bean, “Asset prices, financial imbalances and monetary policy: are inflation targets enough?”, BIS Working Papers, 140 (with discussions by I. Visco and S. Wadhwani, http://www.bis.org/publ/work140.pdf). H. A. Simon, The sciences of the artificial, MIT Press, Cambridge, Mass., 1972, p. 170. BIS central bankers’ speeches reliable data about the initial conditions – the starting point from which the extrapolation is to be made. We must recognize that empirical models reflect historical experience in the values of their parameters and are mostly reliable when it is “business as usual”, that is, as long as our systems are not subjected to unusual pressure. It can be argued that their contribution to making informed decisions is limited, as they tend to become unreliable precisely when, following signs of structural discontinuity, the benefits of correct forecasting are greatest. Indeed, anomalous observations that do not fit the main mechanisms at work in the historical period used for statistical estimates are frequently put aside (“dummied-out”), their information content is neutralized. This is reasonable, as episodic observations of exceptional phenomena are generally inadequate to capture complex inter-relations between economic and financial variables. And yet those very deviations from the norm may contain precious information on how the economy works in conditions other than those usually prevailing. Much of the same reasoning applies to the analysis of financial market developments. The wave of financial innovation in the last two decades was fuelled by the idea, in principle correct and fruitful, that the proliferation of new (and complex) financial instruments, allowing agents to insure against many dimensions of risk, was a way to “complete the markets”, to get closer to the theoretical Arrow-Debreu world, enabling investors to transfer resources efficiently across time, space and states of the world. But this idea relied on the presumption that the world is basically stationary, that the future is pretty much the same as the past, that we can extrapolate from relatively small samples, and that there is a single “data generating process” that we can identify and understand. But we know that the real world is more complex. The determinants of asset prices are not fixed, but vary over time. Asset returns do not follow a normal distribution, as it is assumed by conventional valuation formulas. Myopic behaviour, herding and other types of distorted incentives on the part of individuals and financial institutions can generate negative externalities and move financial markets’ expectations and risk premia away from fundamentals. And, lately, scholarly work has been attributing a new, enhanced role to psychological elements and the recognition that there are limits to what one can know. In the field of the so-called behavioural finance this may even go as far as to validate “irrational” actions. And eminent economists argue that these elements play a role in explaining both conservative attitudes and speculative bubbles.11 The potential limitations of quantitative analysis are therefore not restricted to macroeconomics, econometric modelling and forecasting but also apply to finance. And they may have dire consequences. The case of the CDOs is instructive. These credit derivatives, that in the first half of the last decade recorded an impressive growth, were priced according to valuation models whose results were very sensitive to modest imprecision in parameter estimates and highly exposed to systemic risk (i.e. strongly affected by the performance of the economy as a whole).12 As a result, CDOs not only did not increase the risk bearing capacity of the economies, but their implosion between mid-2007 and mid-2008 was at the core of the global financial crisis. Innovative financial instruments with unsound theoretical foundations may exacerbate negative externalities and be sources of instability in their own right. Rather than in the development of unlikely “catch-all” models, the key to tackling the problems created by discontinuity must lie, first of all, in a better understanding of its nature G. A. Akerlof and R. J. Shiller, Animal spirits: how human psychology drives the economy and why it matters for global capitalism, Princeton, Princeton University Press, 2009. See J. Coval, J. Jurek and E. Stafford, “The economics of structured finance”, Journal of Economic Perspectives, 23, 1, 2009. BIS central bankers’ speeches and so in defining models in which the relations are based on parameters that remain stable in the long term. Research must therefore aim to identify sufficiently fundamental and reasonably dependable mechanisms that do not change over time. To provide sensible accounts of rational choices, quantitative models necessarily have to focus on systematic factors, and draw their own conclusions on the basis of key relations. In this respect it is worth recalling Bruno De Finetti’s argument for a “theory of finance”, made as early as 1957:13 In order for a theory of behaviour to say something, it must necessarily be restricted to that which is derived as the consequence of a few main concepts and criteria and which can accordingly (if somewhat arbitrarily) be defined as ‘rational behaviour’. Then the theory will set out conclusions that are valid in the absence of accessory factors. This is not to deny or downplay the possible presence or importance of such factors; only, it is preferable to shift the study of deviations from the ‘theoretical’ behaviour implied by those conclusions to a later moment and to the detailed plane of complementary observations, rather than cloud all distinctions in a single theoretical construct which, in the attempt to embrace and set on an equal plane the congeries of systematic and accessory factors, would be reduced to a non-theory suitable solely to conclude that all kinds of behaviour are equally possible (for caprice or madness, even, as is in fact the case). Obviously, De Finetti’s “later moment” should not be overlooked in applied research. Against the risk that the theoretical paradigms underlying the approximation of reality implicit in a model may prove particularly inadequate in certain situations, it is useful to employ a battery of different models and cross-checks. This “multi-pronged” approach to modelling and forecasting also makes it possible to more effectively filter and interpret the great mass of partial and fragmentary or even contradictory data that gradually become available. But in dealing with non-ergodic processes, what really is all the more essential is to integrate the signals provided by quantitative models with information outside the models, take stock of related historical experience in its entirety, and intervene on the basis of both theory and sound practical judgement (good sense). In both empirical microeconomics and finance, work is under way to deal with the issues that have been considered here. Deviations from the assumption of normal distributions, “fat tails” and the modelling of extreme events are being taken into account both in research and applications. And it should be recognized that the importance of human behaviour does not imply that economic systems necessarily have to be prone to instability. In fact, the very existence of behavioural uncertainty may tend to create a set of institutions, as well as conventions and habits, which help to deal with the problems highlighted in Keynes’ “beauty context” example and ensure the stability of the main economic processes, as emphasized by Herbert Simon.14 Still, I believe, more attention should be paid to how to account for learning in the crucial adjustment periods that follow extreme events that cannot be simply taken as random extractions from a stable, even if non-normal, probability distribution. Widening the class of probability distributions remains however, for the time being, the practical response to phenomena such as the ones we have been dealing with in this difficult period. B. De Finetti, Lezioni di matematica attuariale, Roma: Edizioni Ricerche, 1957, p. 71 (my translation). H. A. Simon, “The role of expectations in an adaptive or behavioristic model”, in M. J. Bowman (ed.) Expectations, uncertainty and business behavior, New York, Social Sciences Research Council, 1958. BIS central bankers’ speeches Rethinking monetary policy and the role of central banks The crisis has raised important questions on the appropriate tools − conventional versus unconventional measures − and objectives − price versus financial stability − of monetary policy, and more generally on the role of central banks and their relationships with other economic and financial authorities. I would first observe that the crisis has shown that there are crucial advantages in “not tying central banks’ hands too tight”. This was very important in allowing monetary authorities to adopt the appropriate measures to counteract the crisis. Had monetary policy been constrained by a too rigid framework (such as in the past a commodity standard) or too strict pre-specified rules, its ability to react to the crisis would have been severely impaired. The capacity of central banks to adapt the size, scope and type of interventions to the evolution of financial disruptions and to differences in the structure of financial systems was in fact crucial to avoid the occurrence of destructive scenarios and to restore trust. Measures on both sides of the Atlantic were ultimately addressed to ensure the proper functioning of the monetary transmission mechanism, necessary to pursue the final monetary policy objectives of the respective central banks. But the interventions have been tailored to the specific circumstances and to the characteristics of the different economies. For example, the quantitative-easing measures of the Federal Reserve (in a “zero lower bound” context) were aimed at promoting stronger economic growth and a level of inflation consistent with its mandate by intervening on specific segments of the financial markets and of the yield curve. The unconventional measures adopted by the Governing Council of the ECB addressed the malfunctioning of specific markets hit strongly by the crisis and aimed at avoiding major repercussions on bank credit, which plays a predominant role in the financing of the euro area economy. In the assessment of the effectiveness of these measures we need to keep in mind the counterfactual. This is especially evident in the euro area, where the ECB 3-year LTROs decided at the end of 2011 prevented a liquidity crisis in the banking system and the likely major credit crunch that would have followed. Similarly, the announcement in the summer of 2012 of the possibility of intervening in the secondary market for government securities with Outright Monetary Transactions (OMT) was prompted by the need to address market malfunctions and distortions due to the sovereign debt crisis, which were hampering the transmission of monetary policy and risking to ignite a financial collapse with potentially devastating consequences for the European economy. Widening yield spreads between government bonds in the euro area are the consequence of two factors, one national and the other European, linked respectively to the weaknesses of some countries’ economies and public finances (sustainability risk), and to the incompleteness of the European construction and the attendant fears of a break-up of the monetary union (redenomination risk). Consequently, Europe’s response to the sovereign debt crisis has had to be two-pronged: individual countries have pledged to adopt prudent budgetary policies and structural reforms to support competiveness; a far-reaching reform of EU economic governance has been undertaken. The time needed to implement Europe’s complex strategy to counter the economic crisis will be long. The distortions that have affected financial markets and have resulted in significant financial fragmentation across countries can in the meanwhile undermine the transmission of monetary policy and jeopardize the entire process. In July 2012 the yield differential between 10-year Italian BTPs and the equivalent German Bunds was still just over 500 basis points, compared with estimates of about 200 basis points consistent with the predominant Italian and German economic fundamentals. It is in this context that the ECB Governing Council announced the introduction of the OMT program. Countering an excessive increase in sovereign yields when it stems from redenomination risk and distorts monetary policy transmission is fully within the Eurosystem’s mandate. BIS central bankers’ speeches The OMT will only be activated in the presence of severe market strains and are confined to the securities of countries adhering to a macroeconomic adjustment or precautionary programme financed with the resources of the European Stability Mechanism (ESM, a financial backstop jointly funded by EU countries set up during the crisis). Their continued operation then depends on observing the conditions attached to the programme. There are no ex ante limitations on the duration or amount of the intervention. This initiative has been made possible by the credibility of the Eurosystem and the progress made with both national reforms and the design of European governance. The two factors fuelling the crisis are not independent. On the one hand, fears of euro reversibility are linked in the first place to those concerning the sustainability of public debts and the competitiveness of member countries. On the other hand, the financing of the programmes with ESM resources is an incentive to further strengthen the governance of the Union, which is essential to achieve a permanent reduction in the redenomination risk and the related component of the interest rate differential. Monetary policy can guarantee stability only if the euro-area’s economic fundamentals and institutional architecture are consistent with it. The announcement of OMT produced immediate benefits: medium- and long-term yields in the countries under pressure decreased and the fragmentation of markets along national borders was attenuated. Albeit with fluctuations linked to temporary tensions at the national level and to the remaining, pronounced uncertainty about the determination of all member states to proceed with the strengthening of the Union, the yield spreads between euro-area government securities remained on a downward trend. That between ten-year BTPs and Bunds is about 250 basis points today. To ensure stability over the longer run, the effort to reform the European governance has been stepped up. The subsequent stages are outlined in the report Towards a Genuine Economic and Monetary Union (presented in June 2012 and updated in December by the President of the European Council, working closely with the Presidents of the European Commission, the Eurogroup and the ECB) and in the Blueprint for a Deep and Genuine Economic and Monetary Union published by the Commission last November. Both documents envisage a banking union, the introduction of autonomous fiscal capacity for the whole euro area, and a common budget; they set the scene for the eventual political union. The Banking Union is a keystone of institutional reform. It has three key components: a single supervisory mechanism (SSM), a single bank resolution mechanism, and a harmonized deposit insurance scheme. Such an important institutional innovation will require an organizational adaptation as far-reaching and at least as complex as that leading to the single monetary policy, with substantial investment in human resources and technical infrastructure. Priority has been given to the launch of the SSM, but work must progress expeditiously also on the other two components, which are both crucial to align supervisory and crisis management responsibilities, as well as to break the perverse bank-sovereign loop. The harmonization of regulatory and supervisory practices is a precondition for success; it will be crucial in the comprehensive assessment of banks’ balance sheets that will be carried out before the launch of the SSM. Related to the debate on the appropriate measures, the crisis has raised concerns about the interaction and possible conflicts between policies addressed to maintain price stability and those aimed at preserving financial stability. It has also raised the question of whether central banks should revise their objectives or strategies. In my view there is no need to question the current objectives; in the case of the Eurosystem, that of preserving (medium term) price stability. I do not believe, in particular, that financial stability should become an explicit objective of monetary policy at the par with price stability, for two main reasons: first, the benefits of our monetary framework have become more – not less – evident during the crisis, with inflation expectations remaining well-anchored throughout; second, assigning financial stability as an explicit additional objective to monetary policy could risk blurring responsibilities, increasing moral hazard and creating BIS central bankers’ speeches potential conflicts. However, I believe that there is no question that preserving financial stability resides fully within the responsibilities of (even if perhaps not only) central banks. Indeed, the crisis has not put into question the idea that over longer horizons there is no trade-off between price stability and financial stability objectives – rather, there are synergies. But it has shown that short-term interactions may be very complex and conflicts cannot be excluded. It has become clearer than it was before the crisis that price and financial stability are directly and strongly interconnected, that risks to any of these two objectives can quickly spread to the other, create dangerous loops and quickly undermine trust in financial markets. This certainly implies that the instruments of monetary policy are not neutral with respect to financial stability. It also calls to address the latter with specific policy tools. But it also calls for efforts in the conduct of monetary policy, along three dimensions: the information set used in the assessment of the risks for price stability; pre-emptive reaction to signals of financial instability; and effective communication. Monetary authorities need to monitor a broader range of indicators, look for early signals of financial instability, develop models capable to capture the interactions between the financial sector and the real economy and be cautious in using standard macro-econometric models in circumstances of financial unrest. Although central banks should not regularly intervene to exert a direct control on asset prices, they should not wait until a crash occurs before acting, given that the costs of this strategy have proved to be very large; rather they should lean against the formation of financial imbalances and not be shy to react to early signals of financial instability. Indeed, this is something of which one could have been convinced of even before the last crisis. Monetary authorities should not overlook the potential impact, not only of their actions (or inactions), but also of their communication on the solution of financial stability problems and the consequent repercussions on price stability. The implementation of new frameworks of policies, however, is all but easy. Building models which are able to capture interactions between price and financial stability is difficult. As to macroprudential policy, we still lack a well defined analytical apparatus and operational definitions of its objectives and instruments. Indicators and early warning signals are available, but a coherent framework to interpret them and to measure the effectiveness of macroprudential policy is still lacking. Preliminary results confirm that it has some potential to stabilise the economy over and above what can be achieved by monetary policy alone, but that this varies depending on the type of shock or setup considered.15 I would dare to say that proper understanding of how this can be effectively achieved is still in the making. Final remarks The crisis has shown that benign neglect should never have been an option. It has called for a major overhaul of the regulatory and supervisory financial framework, especially at an international level. In a globalized financial marketplace, with large and powerful participants, individual action by national authorities would be bound to fail. By the same token, the boundaries of supervision should be widened to encompass all relevant intermediaries, regardless of the specific industry sector they belong to. I have discussed the work underway, highlighted the results achieved and stressed the areas where more effort is needed. P. Angelini, S. Neri and F. Panetta, “Monetary and macroprudential policies,” Banca d’Italia, Working Papers, 801, March 2011 (http://www.bancaditalia.it/pubblicazioni/econo/temidi/td11/td801_11/td_801/tema_801.pdf). See also P. Angelini, S. Nicoletti-Altimari and I. Visco, “Macroprudential, microprudential and monetary policies: conflicts, complementarities and trade-offs”, in A. Dombret and O. Lucius (eds.), Stability of the Financial System: Illusion or Feasible Concept?, Edward Elgar, Cheltenham, UK, 2013 (also Banca d’Italia, Occasional Papers, 140, November 2012, http://www.bancaditalia.it/pubblicazioni/econo/quest_ecofin_2/qef140/QEF_140.pdf). BIS central bankers’ speeches The correct conduct of financial business also requires competence and good faith on the part of intermediaries, both factors being decisive to ensure sound and prudent management and preserve the confidence of savers. This necessity is heightened by the complexity of the external environment, by the presence of large intermediaries, and by the economic and reputational damage that can result from illicit behaviour. No market can function without rules, nor is prudent management possible without correct conduct, embodied not only in scrupulous compliance with the law and the supervisory rules but also in complete adherence to business ethics. The dramatic events of the past five years have highlighted the limitations of modelling and quantitative analysis in finance and in economics. The common assumption of stationarity is at odds with the unpredictably changeable nature of the real world. This is not to say that all the analytical efforts of the past and the progress achieved should be disregarded. It means rather that in order to make the best out of them one needs to remember that models are by necessity “local” approximations to very complex phenomena and they should be used with sound practical judgment as a framework, not a straightjacket, for our decision-making. Quantitative analysis and modelling can also help to establish institutional and behavioural norms to rein in patterns of instability and developing proper learning devices to deal with major shocks and regime changes. In turn, models should take into account the impact of such norms on economic developments. Central banks have a crucial role to play. There are clear complementarities between financial and monetary stability. Sometimes these are formally recognized in their official mandate, but even when this is not the case, central banks must take them into account in their policy decisions. In this respect, I would like to quote from a book by the brilliant Banca d’Italia economist Curzio Giannini, who passed away prematurely about ten years ago. In that “beautifully written and illuminating” work, as Charles Goodhart describes it in his foreword, Curzio clearly saw the likely consequences of financial developments, and concluded:16 In the years to come, the most interesting developments will probably be precisely in the sphere of supervision and regulation. […] Whatever its detractors may say, the central bank has no need to move into new lines of business. Capitalism generated the central bank and capitalism will come to it again, even if the current infatuation with the financial markets’ self-regulating capacity were to endure. […] The central bank produces an intangible but essential good – trust – of which capitalism (based as it is on a pyramid of paper if not mere electronic signals) has an immense need. We must not forget that trust, or its synonym “confidence”, derives from the Latin fides, meaning faith, which cannot be produced simply by contract. In fact the legitimacy of central banks does not lie in their policy activism, or the ability to generate income, or even, save in a highly indirect sense, their efficiency. Rather, […] it derives from competence, moderation, the long-term approach, and the refusal to take any tasks beyond their primary role. If, as I am sure, there is another phase in the development of central banking, it will spring from these values. In the end this is, perhaps, what society should expect, if not from the financial sector, from those who are called to look after financial stability. C. Giannini, The age of central banks, Edward Elgar, Cheltenham, UK, 2011, p. 255 and pp. 258–259, English translation, L’età delle banche centrali, Bologna, Il Mulino, 2004. BIS central bankers’ speeches | bank of italy | 2,013 | 10 |
Remarks by Mr Luigi Federico Signorini, Deputy Director General of the Bank of Italy, at the EU Finance Day for SMEs, Italy, Rome, 18 October 2013. | Luigi Federico Signorini: Building a strong financial system to assist innovative SMEs Remarks by Mr Luigi Federico Signorini, Deputy Director General of the Bank of Italy, at the EU Finance Day for SMEs, Italy, Rome, 18 October 2013. * 1. * * Small and medium-sized enterprises in the European economy Small and medium-sized enterprises (SMEs) are a key feature of the European economic landscape. They account for 99 per cent of all EU firms, employ 67 per cent of all payroll workers and generate 58 per cent of value added. Their contribution to economic activity varies significantly from sector to sector; in 2010 their contribution to value added ranged from under 25 per cent in energy to over 80 per cent in construction and real estate. Cross-country variability is also significant: SMEs’ share was lower in the United Kingdom (50 per cent) and higher in Portugal, Spain and Italy. In Italy SMEs account for about 80 per cent of total employment and 68 per cent of business value added. In 2011 micro enterprises – firms with fewer than 10 employees – accounted for around a third of the Italian firms’ total value added, 8 percentage points higher than the European average. SMEs rely heavily on internal sources (retained earnings) to finance ongoing activities and investment; their funding consists more of debt than equity and, among debt instruments, bank loans outweigh securities. The role of banks in SMEs’ financing is linked to their ability to reduce the large information asymmetries typical of small firms. It is favoured by firms’ inherent difficulty in going public, and sometimes their reluctance to do so, which limits their ability to place securities directly with non-bank intermediaries. Specifically, SMEs’ access to capital markets is often hampered by high fiscal and administrative costs, lack of transparency and the low propensity of family businesses to dilute control. Access to finance is a major challenge for SMEs in normal times; it has been much more so in Europe over the past five years. The deep recession that hit most countries – a double-dip recession in some cases – dried up internal resources; recurrent crises of confidence in financial markets, which put a brake on funding flows, and mounting bad loans made banks tighten their lending policies. These problems have been addressed with a variety of economic policy measures. Central banks have used monetary tools to ease the liquidity crisis of the financial sector; European institutions and national governments have used public resources both to help meet the SMEs’ short-term financing needs and to fund guarantee schemes so as to mitigate credit risk. Regulators have envisaged specific provisions for SMEs in revising and strengthening the rules on banks’ capital requirements. Supervisory authorities have put pressure on banks to bolster their capital and thus their ability to withstand macroeconomic risks. In what follows I briefly summarize the effects of the crisis and recall the main contributions of the different policies to facilitate SMEs’ access to finance in these circumstances, with special attention to the Italian case. I conclude with some general thoughts on the financial architecture of SMEs, with a view to making them more robust to external shocks and to promoting the long-term growth of our economies. 2. The crisis The financial crisis in 2008 and the ensuing recession left a heavy legacy of joblessness and lost growth in the euro area. The area saw a mild recovery in 2010, but then the sharp worsening of the global growth outlook in the second part of 2011 and the EU’s slowness in shaping policies to counter the crisis, together with a perceived risk of a break-up of the BIS central bankers’ speeches monetary union, fuelled renewed tensions. The economic impact of the so-called sovereign debt crisis was stronger in countries with larger internal or external imbalances and was further reinforced by financial markets’ fragmentation along national lines. The crisis quickly affected banks’ funding conditions, since sovereign spreads have a significant impact on banks’ funding costs, and hence on their ability to provide credit to nonfinancial corporations. Cross-country disparities in both the growth and the cost of loans to firms mounted during 2011; they moderated somewhat in 2012 and the first half of 2013 but they remain significant to this day. The tightening of bank lending to firms was widespread, but findings drawn from qualitative and quantitative data consistently suggest that the effects were most severe for SMEs, owing to their limited ability to tap alternative sources of finance. In Italy, where the increase in the sovereign risk spreads was substantial and the share of bank-dependent SMEs very large, these developments had even heavier repercussions than elsewhere. The average interest rate on new loans up to €250,000, a proxy for the cost of credit to SMEs, rose more steeply than that on new loans greater than €1 million. Moreover, large industrial groups, most of them listed, had in principle the alternative of going to the market as at least a partial substitute for bank credit, an option that is not available to most SMEs. The adverse impact on credit supply conditions of banks’ difficulty in accessing wholesale funds moderated in 2012, partly as a consequence of the extraordinary monetary measures adopted by the ECB, a point to which I shall return. Meanwhile, however, the crisis had spread again to the real economy. The worsening macroeconomic outlook in Italy and the consequent increase in credit risk were again reflected in a credit tightening. In 2012 and in 2013, the number of firms defaulting on loans increased substantially: in the second quarter of 2013 the ratio of new bad debts to outstanding business loans reached 4.7 per cent, 1.5 percentage points higher than a year earlier. The related deterioration in banks’ asset quality has also contributed to the restrictiveness of lending standards. Credit rationing hits SMEs disproportionately. While slightly less common in the immediate past, according to the latest qualitative data, rationing is still a constraint on the economy. It is important to understand that relaxing credit standards is not the solution. A robust, resilient banking system is a prerequisite for a functioning credit market. Prudence as regards banks’ assets is essential to ensure safety for depositors and orderly access to funding markets. Confidence is indispensable. What is necessary is to ensure orderly funding conditions, enhance banks’ resilience without imposing undue procyclical effects on the economy, and diversify the sources of finance for SMEs, with a view to fostering entrepreneurship, innovation and growth. 3. Monetary policy The ECB moved swiftly to counteract the effects of the sovereign crisis on the economy and the impairment of monetary policy transmission across euro-area countries. First, it adopted a highly accommodative monetary policy stance, reducing official rates to their all-time low, with the rate on main refinancing operations now at 0.50 per cent. Second, it took a number of non-conventional monetary policy measures to reduce the fragmentation of financial conditions across the euro area and avoid an unprecedented credit crunch, which would have had dire consequences on the macroeconomic outlook and price dynamics of the euro area as a whole. In particular, in order to ensure more uniform wholesale funding conditions, on 8 December 2011 the ECB announced two 3-year longer-term refinancing operations, to be conducted as fixed rate tender procedures with full allotment. Further, to guarantee wide access to its refinancing operations, it also increased the range of eligible collateral by reducing the rating threshold for certain asset-backed securities and allowing national central banks to accept as BIS central bankers’ speeches collateral additional performing credit claims (i.e. bank loans) that satisfied certain criteria. The set of eligible collateral was further increased during 2012, to support bank lending. These decisions, together with the announcement of Outright Monetary Transactions in August 2012, have been crucial in reducing financial segmentation and mitigating banks’ funding difficulties. Within the policy framework defined by the ECB Governing Council, the Bank of Italy has taken several further steps to ease the difficulties in the Italian credit market for credit-worthy firms that depend most on it. In February 2012, the Bank began to accept as collateral, subject to strict risk-control measures, so-called Additional Credit Claims (ACC), that is to say, performing bank loans that satisfy eligibility criteria different from those normally required by the Eurosystem. Specifically, the Bank of Italy has accepted some additional types of loans and allowed banks to use its internal credit assessment system for rating them, which has made it easier for small banks to participate in Eurosystem refinancing operations. Small locally-based banks, which typically have no internal rating system, traditionally play an important role in lending to SMEs. Also, like other Eurosystem national central banks, the Bank of Italy has lowered the minimum amount accepted for both ordinary and additional bank loans from €500,000 to €100,000, to allow loans granted to smaller firms to be used as collateral. We are working to enlarge the set of loans that comply with all Eurosystem eligibility requirements. The unconventional monetary measures adopted by the ECB in 2011–2012 were effective in easing tensions in government bond markets and have had a beneficial impact on credit supply and money market conditions, supporting the economy and preserving price stability in the euro area. Our econometric analyses suggest that the effects of the ECB’s extraordinary measures added more than two percentage points to the growth of Italy’s GDP in the period 2012–2013 and were transmitted mainly through the improvement in credit supply conditions. While the policies did not prevent the Italian economy from falling into recession, they did keep the credit crunch from being still more severe and the fall in output even larger. 4. Strengthening the banking sector A healthy banking industry is essential to maintaining a stable flow of financial resources to the economy, and to smaller firms in particular. Strengthening banks’ capacity to absorb shocks has been a major concern of policy makers, regulators and supervisors. On the regulatory side, the changes have been far-reaching. Policy makers and the public are well aware of the international drive to improve banking prudential standards and to overcome the regulatory failures that had become glaring with the financial crisis. The effort is ongoing. Capital rules have been strengthened. Liquidity rules, a serious blind spot of the previous international system of standards, will be introduced. Systemically important banks, whose failure may trigger widespread disruption, will be subject to stricter standards. On the supervisory side, these have been times of severe testing. The action to reinforce capital and liquidity standards was and is central. At the same time, however, it is essential that banks achieve this strengthening without undue restriction to credit. Capital reinforcement is the key. From the very beginning of the financial crisis, the Bank of Italy has closely monitored the liquidity and the capital of Italian banks, prompting actions to increase high quality capital and cope with an increasingly risky environment. At the end of June 2013, the core tier 1 ratio had risen to an average of 11.2 per cent from 7.0 per cent in 2008. In order for these actions to take place without aggravating lending conditions, we have insisted on the reduction of banks’ costs and the injection of new capital; we asked banks’ shareholders to forgo dividends, managers to reduce or cancel bonuses. BIS central bankers’ speeches This has not been without effect. As the IMF stated in its recent Financial System Stability Assessment for Italy, the provision of additional domestic resources, both deposits and capital, has enabled the Italian banking system to withstand the dramatic sequence of external shocks to the global and the European economy since 2007 almost exclusively with its own resources. The IMF also noted that the impact of additional “downside risks” on the banking system, as measured by several stress test exercises, would be “substantially cushioned by the existing capital buffer”. It concluded that the banking system, though hard-hit by the crisis, has managed to avoid capital shortfalls that would have had dramatic consequences for the real economy and, most importantly, is in a position to prevent capital shortages in the near future. During the crisis, the fragmentation of financial markets along national lines has also had a major impact on Italian banks. This has entailed high costs and limited availability of wholesale funding, and has affected domestic credit conditions. While the ECB’s actions have eased tensions in the short term, a more structural action is required to make Europe’s banks work as one system, one market. In a heavily regulated industry like banking, the single market requires a single framework for regulation and supervision; otherwise it cannot work properly, especially in difficult times. The creation of the Banking Union is a keystone of the institutional reform to ensure stability in the euro area and in the EU at large. It should eliminate fragmentation, leaving only that portion of extra funding costs for banks that is associated with genuine extra credit risk. The Banking Union comprises three key components: a single supervisory mechanism (SSM), centred on the ECB and based on the expertise of national supervisory authorities; a single resolution mechanism (SRM), which is central to ensuring that the responsibilities of supervising banks and managing their recovery or resolution are effectively aligned; and a harmonized deposit guarantee fund financed by the industry, whose mission is to prevent bank runs. In the summer of 2012 the European leaders decided to give priority to the construction of the first component, the Single Supervisory Mechanism, comprising the ECB and the national supervisory authorities. But this is a three-legged animal: it cannot be asked to stand on one foot. The resolution part is already under development. The third leg, a common deposit guarantee fund, must remain a target. The purpose of the Banking Union is to bring substantial benefits to the Single Market, improve the monitoring, control and mitigation of the systemic risks that stem from the interconnectedness of banks and markets, break the perverse feedback loop between banks and sovereigns and counter the ring-fencing trends observed in the last years, thus fostering financial integration. 5. SMEs and the financial sector Policies to improve the institutional environment must be complemented by actions to foster an efficient and diversified financial system that can adequately serve a set of enterprises whose financing requirements are quite heterogeneous, depending on firms’ characteristics. For smaller firms, which will continue to rely heavily on bank loans, it is essential that the prudential rules on bank capital be designed so as to avoid a negative impact on credit supply. The Basel II framework (CRD in Europe), which went into effect in 2007–08, had already envisaged more favourable prudential treatment for loans to SMEs than other corporate loans, justified by their reduced systemic impact. The 4th capital requirements directive/capital requirements regulation has introduced a further reduction in capital absorption for this class of exposures, facilitating bank lending to SMEs. Such a discount will apply in the form of a “supporting factor”, an SME-specific coefficient that reduces – given specific conditions – capital requirements for lending to SMEs by around one fourth. BIS central bankers’ speeches Loan securitizations represent an opportunity for smaller firms to access market finance. These operations have got a bad name during the crisis. But there are good securitizations and bad ones. Opaque, complex, multiple-stage securitizations have shown, beyond all possible doubt, their potential for wreaking havoc. They must be avoided. But a simple, transparent securitization framework can be useful to the growth of lending. The regulatory environment should encourage the adoption of two key features: first, risk retention, in order to align the interests of all parties; second, simplicity and transparency, in order to allow investors to assess the quality of the underlying assets. The interest of investors in securitization instruments depends critically on the regulatory environment. The Basel Committee is working on a comprehensive review of the prudential treatment of the asset-backed securities held by banks, addressing the shortcomings of the current regulation by making capital requirements more prudent and risk-sensitive, reducing reliance on external credit ratings and easing cliff effects when credit quality deteriorates. The Committee is now reviewing the calibration of the new approach, following comments on a preliminary consultation. In setting the new capital charges the Committee must seek to strike a good balance. The Bank of Italy is taking an active part in the revision of the securitization framework. We also appreciate the international discussion on the recovery of securitization markets characterized by simple and transparent instruments. The promotion of these operations can bolster investor confidence and work to the direct benefit of the real economy. For firms with higher growth potential, the financial system must offer non-bank financing solutions, which fit their risk profile better. Although bank loans will certainly remain the dominant source of external financing for SMEs, long-term investments are better financed by equity capital. In particular, share capital is preferable to foster innovation and growth in businesses with uncertain results and pronounced information asymmetries. While banks can count on guarantees and long-term relationships with firms to reduce the information asymmetries, equity capital enables investors to benefit in full from the returns to successful innovation. Banks must understand that there is, here, a long-term benefit for them, too. As margins on traditional intermediation shrink and the need to contain leverage sets limits on loan growth, banks should constantly improve their ability to provide more diversified financial services to firms, especially SMEs. They can play a key (and profitable) role in accompanying firms along a path to a better balanced, more robust and flexible funding structure. Progress in this direction would be beneficial both for banks and for their customers. A number of empirical studies have found a strong positive causal link between the availability of capital and investment in innovation. A recent study for Italy concludes that the issue of shares increases the probability of a firm’s undertaking R&D investment by around one third. Venture capitalists and other investors specializing in financing innovative enterprises are undersized in Europe by comparison with the US. Long-term financing, and equity financing in particular, is hampered by both demand and supply factors. On the demand side, the costs of disclosing the relevant information to external investors are often very high compared to the scale of business; often small firms’ problems of asymmetric information are amplified by their family-based management model. On the supply side, access to market financing is hindered by the low propensity of institutional investors to invest in these companies’ securities. The high risk and low liquidity of SMEs’ securities do not fit the preferences of most institutional investors, which often lack the expertise to manage the risks associated with this asset class. Designing policies to foster investment in securities issued by SMEs is a difficult task, and in the past the results have often been disappointing. But the challenge is worth taking up. The BIS central bankers’ speeches Commission’s March 2013 Green Paper on long-term financing to support structural economic reform and return to a long-term trend of economic growth in Europe specifies a number of proposals that constitute a solid basis for future work. The essential goal is to make small enterprises and the entire economy more resilient vis-à-vis shocks to banks and to enhance the capacity to finance growth and innovation. 6. Conclusion Small and medium-sized enterprises in Europe have been hit hard by the crisis, and in several countries their ability to raise external finance has been and still is constrained. A good many counter-measures have been taken, ranging from monetary policy to the allocation of resources from national and European budgets. More are in the pipeline. Regulatory reforms and the creation of a European Banking Union will help restore confidence in the financial system and in the banking industry. Once the damage done by such a deep and protracted crisis has been repaired, it will be vital for the prosperity of Europe to build a thriving business environment in which smart ideas can be readily transformed into entrepreneurial initiatives. SMEs are central to long-term economic development in many sectors. SMEs can be, and indeed often are, an engine for growth. Italy has seen a thriving system of small, innovative, enterprising firms, whose growth has been central to internal and external development. On the global level, most of the breakthrough innovations that have reshaped the world economy in recent decades have come from start-ups and SMEs. To stay successful, SMEs must be able to adapt, transform themselves and grow. The social, institutional, financial environment plays a fundamental enabling role. This is true for all firms, but even more so for SMEs, which have a limited ability to internalize the production of key inputs like human capital and interconnection services. We need to increase the proportion of dynamic small firms that work close to the technological frontier and whose smallness is just a stage of their life cycle. This requires action on several fronts: human capital, infrastructures and finance. Building a financial system that can meet the needs of innovative SMEs with high growth prospects is a challenge we must take up. We must look beyond the crisis. Even as we act to improve the traditional bank-centred model of business finance and to make it more resilient, we need to create more scope for markets and non-bank intermediaries. There are no ready-made solutions. Best practices around the world and our own past experience must serve as our guide. All the key actors, the financial industry, policy makers and entrepreneurs must do their part. 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Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the 89th World Savings Day, organised by the Association of Italian Savings Banks (ACRI), Rome, 30 October 2013. | Ignazio Visco: 2013 World Savings Day Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the 89th World Savings Day, organised by the Association of Italian Savings Banks (ACRI), Rome, 30 October 2013. * * * After a prolonged decline, in Italy there has been a slight recovery in saving in the last two years, from under 17 per cent of national income in 2010 to almost 18 per cent in 2012. The increase reflects a reduction in the negative contribution of the public sector. Private sector saving has continued to fall, but more slowly. With the continuation of the recession Italian households, which initially had buffered its impact on their spending behaviour by reducing their saving, revised their spending plans downwards, adjusting them to lower permanent income. A factor was the acute uncertainty over the valuation of wealth, in turn linked to the prolonged strains in the financial and realestate markets. In 2012 consumption fell sharply, in line with disposable income, and it remains weak, notwithstanding the first signs of improvement in households’ purchasing power. In the first half of 2013 GDP continued to decline, albeit at a more moderate pace. In the context of a euro-area recovery that is both slow and uneven, the latest indicators for Italy are consistent with GDP stabilizing in the third quarter and returning to modest growth in the fourth. Uncertainty remains high. In the summer the contraction in industrial production eased. About half of the firms surveyed by the Bank of Italy reported that the worst of the crisis had passed; smaller firms and those exporting less are still in greater difficulty. The trend in capital formation also seems to be turning round. In the second quarter purchases of machinery and equipment recorded their first increase in more than two years. The prolonged decline in construction is slowing. An acceleration of investment in the remaining part of this year and next year is indispensable for renewed economic growth. Savings must flow to businesses through a revival of bank lending but also through greater direct access to the capital markets to reduce firms’ dependence on the banks. This means overcoming a structural lag of our financial system, manifested in the small number of listed companies and the limited level of stock market capitalization in relation to the size of the real economy. Business loans have decreased by almost 8 per cent (more than €70 billion) since the end of 2011 when the first, sharp contraction occurred. As a proportion of GDP they have fallen from more than 59 per cent in November 2011 to about 55 per cent in September 2013. The unfavourable macroeconomic conditions continue to restrain credit demand and supply; loan supply is affected by the increase in firms’ credit risk and the related adverse selection effects. Italian firms’ financial leverage is high by international standards: in 2012 the ratio of financial debt to the sum of that debt and shareholders’ equity at market prices was 49 per cent in Italy against 34 per cent in France and the United States, 39 per cent in Germany and 42 per cent in the United Kingdom and in the euro area as a whole. Analyses of firms’ financial statements indicate that these differences are due only in part to dissimilarities in sectoral and size composition. Italian households invest only a small amount in listed shares (2 per cent of their total financial assets, against 4 per cent in Germany and on average in the euro area). Only a small proportion of Italian investment funds invest widely in shares. The current financial situation should spur banks and firms to overcome this state of affairs. Difficult credit conditions necessitate recourse to alternative channels of funding for sound businesses with good growth prospects. By providing the necessary services to accompany these businesses on the capital markets, the banks can sustain their own earnings and at the same time reduce their risks, although conflicts of interest must be avoided. BIS central bankers’ speeches Inflows of foreign capital could help to improve firms’ funding conditions. After the substantial outflow between the summer of 2011 and the first four months of 2012, foreign portfolio investment is picking up; the easing of financial tensions, assisted by the unconventional monetary policy measures taken by the Eurosystem, has contributed to this. The maintenance of balanced public finances and the continuation of reform actions to support growth – accompanied by progress towards the completion of the European Union – can improve confidence and reduce the perception of investment risks in our country, allowing us to consolidate the recovery of capital flows from abroad. The Italian banking system Italian banks have weathered the global financial crisis, a double-dip recession, and the sovereign debt tensions. The capital strengthening carried out in the course of the last, difficult years has been substantial; in Italy, unlike other countries, it was achieved virtually without recourse to public funds. For the system as a whole, between the end of 2007 and June 2013 core tier 1 capital increased by €39 billion, to almost €180 billion. The core tier 1 ratio accordingly rose from 7.1 to 10.9 per cent; for the top five banking groups it reached 11.2 per cent, in line with the average for the main European banks. Banks’ liquidity position benefited from the Eurosystem’s three-year refinancing operations, which enabled them to offset the fall in international funding owing to the sovereign debt crisis and to build up bond redemption reserves. The increase in banks’ exposure to Italian government securities – from €220 billion at the end of 2011 to €415 billion in June 2013 – reflected the economic advantage and necessity of temporarily investing the liquidity obtained from the Eurosystem in a setting of increased riskiness of lending. In the third quarter this exposure decreased by almost €10 billion. With the economic recovery and the attendant improvement in firms’ prospects, it is likely that banks will review their fund allocation policies. Aside from government securities, assets eligible as collateral in refinancing operations include own-use government-guaranteed bank bonds that will mature over the next few years and, in any case, as of 1 March 2015 can no longer be pledged directly by the issuer. Sufficient collateral must be maintained to replace the assets that are no longer eligible, in order to make up for any falls in value. The Bank of Italy is currently developing new ways of facilitating the use of certain types of loan that are especially widespread in our country, such as current account credit lines; some contractual changes will be required to ensure consistency with the ECB standards. The procedures for accepting loan portfolios are also being defined. The adoption of the Bank of Italy’s internal assessment model, authorized last July by the ECB, will enable small banks in particular to avoid penalizations in terms of valuation haircuts. Efforts to regain full access to the international markets must continue. Massive recourse to central bank liquidity cannot be a permanent mode of funding for banks. The view that Italy’s banking system stands in dire need of recapitalization is unfounded. Only recently the International Monetary Fund published the results of its latest Financial Sector Assessment for Italy. I have already had occasion to point out that the IMF’s stress tests, and similar exercises conducted by the Bank of Italy, show that the system can withstand not only the macroeconomic weakness posited in the baseline scenario for 2013–15 but also a less favourable scenario in which GDP growth is cumulatively more than 4 percentage points lower in the same three years. In this case, the additional capital required by some intermediaries in order to meet the minimum regulatory requirements would be limited; depending on the definitions used, it would amount to between €6 billion and €14 billion. These are – it is worth emphasizing – hypothetical capital needs that would arise only in an improbable scenario. BIS central bankers’ speeches The Financial Sector Assessment Program’s findings dovetail with the analyses that the IMF itself has conducted at aggregate level in its recent Global Financial Stability Report, which estimates the losses on loans to firms that the Italian banking system could face in an adverse economic scenario at €125 billion for the two years 2014–15. Considering the writedowns already taken, this amount is reduced to €53 billion, less than the gross profits banks are expected to make in the same two years. The losses, therefore, should not affect the system’s total capital. Italian banks have been protected first and foremost by business models that remain rooted in traditional retail banking business. In part thanks to the attentive supervision of the Bank of Italy, the system avoided the kind of massive investments in “toxic” securities seen elsewhere, often with recourse to off-balance-sheet vehicles. The depth of the crisis faced by our country nonetheless weighs on the outlook for banks. Compared with the third quarter of 2007 gross domestic product has fallen by almost 9 per cent and industrial production by roughly one fourth. It should surprise no one that banks are encountering difficulties and struggling to support the economy fully. They suffered as a result of the sovereign debt crisis and the ensuing deterioration of funding conditions in international markets. The protracted recession continues to have repercussions on the quality of loans, above all to firms. In some instances difficulties have arisen from transactions that are incompatible with sound and prudent management, at times even fraudulent. The supervisory action of the Bank of Italy has been intense; when necessary, special administrative measures have been imposed. In the second quarter of this year the annualized ratio of new bad debts to total bank loans reached 2.9 per cent. Supervision – both off- and on-site – is closely monitoring the evolution of credit and its quality. The objective is to make sure that the coverage ratios for nonperforming loans remain adequate and are raised when necessary. Far from harming the banks, our action will strengthen them, reassuring markets about the soundness of their balance sheets. Bad debts amount to about €75 billion net of write-downs and are more than covered for the system as a whole by collateral and personal guarantees. Other net nonperforming loans (substandard, restructured and overdue loans), whose expected loss rates are significantly lower than those of bad debts, amounted to about €110 billion. Partly as a result of the checks carried out by us in late 2012 and early this year, the coverage ratio for the aggregate of non-performing loans has stabilized. In June of last year it was 39 per cent for the whole of the system and 41 per cent for the top five groups. The average for the largest European banks is slightly higher (43 per cent), but the criteria for the classification of impaired loans are less stringent than those adopted in Italy. The measures contained in the draft Stability Law to reduce the time horizon over which write-downs and loan losses are deductible remove some of the tax disadvantage that has long penalized Italian banks compared with foreign competitors and that becomes even more significant from the perspective of the Single Supervisory Mechanism. The new legislation, in line with the recommendations issued on several occasions by the International Monetary Fund, will encourage banks to adopt the most conservative practices when writing down bad loans, thus improving the transparency of their balance sheets. The gross profits of the banks amounted to €32 billion per year on average in 2011–12 and to €17 billion in the first half of this year. Loan losses continue to absorb most of this, however. If this situation were to persist for a long time, the low level of net profitability would inevitably weigh on their financial situation. The need to counter the effects of the crisis makes it urgent to address the structural problems of the banking system, including those relating to governance. These are issues on which I have already spoken in the past, but must return to because they remain largely unresolved. The failure to solve them has a negative impact on banks’ efficiency and profitability and ultimately on the correct allocation of savings in the economy. BIS central bankers’ speeches The ratio of operating costs to gross income, which amounted to 62 per cent in the first six months of this year, is about 5 percentage points higher than the average for the leading European banks. Taking into account the growth rate of lending, reduced unit margins and weak demand for asset management products, in the current situation it is difficult to foresee a significant increase in banks’ revenues. In the short term the recovery of profitability requires decisive action on costs, including labour costs, which represent more than half of the total. Some progress has been made on this front, but we need all parties to participate, and take responsibility, in an action not unlike the one successfully launched in the second half of the 1990s to reduce the gap with the leading foreign banking systems. A major part of this effort must consist in a rigorous review of executive compensation. Cost containment requires a radical rethinking of the distribution channels to make full use of the opportunities offered by technological innovation. Standardized and low-value-added services can be distributed at lower cost through remote channels, and the traditional distribution network should be reviewed to concentrate on the supply of more complex products. It is not an easy task, and it requires a profound transformation of banks’ organization and operating structure and considerable investment in staff training. Targeted mergers and acquisitions, based on robust economic premises, may facilitate the restructuring and the recovery of efficiency. The process of financial integration in the euro area is encouraging a wider use of technology. The transition to the new payment standards under the Single Euro Payments Area, which will be completed by 1 February next year, is an important element. It affects firms, consumers, banks and other payment service providers. The availability of efficient services will benefit the economy as a whole; according to studies sponsored by the European Commission, the efficiency gains resulting from the transition to the new standards will be in the order of 0.2 per cent of European GDP. The Bank of Italy is committed to ensuring that all those involved in the initiative put in place the necessary organizational, technical and procedural arrangements within the time limits. Corporate reorganization, including within groups, and more streamlined boards are needed in order to improve the chain of decision-making, by making directors more accountable and eliminating unnecessary costs. Mechanisms must be adopted to prevent a misinterpretation of banks’ relationship with their local area from steering lending and investment activity in the wrong direction, putting the soundness of banks’ balance sheets at risk and hindering the efficient allocation of resources. In addition to disbursing credit, Italian banks often participate directly in firms’ capital. Such equity links must not be a source of distortions in lending decisions or give rise to attempts to prevent debtors’ difficulties from emerging. These risks, like all others deriving from relationships with counterparties closely linked to banks, must be appropriately monitored by banks’ governing bodies. The supervisory authority cannot intervene preventively with regard to individual transactions, even if they are with related parties. It will, however, continue to exercise its control activity, carefully assessing the ways in which transactions are carried out and their impact on banks’ risk profiles and their sound and prudent management; it will require any shortcomings to be corrected. The business of the large cooperative banks is no longer restricted to a limited local area. Their original corporate structures must not be an obstacle to the strengthening of their capital bases. The stability of banks’ ownership structure is of value, but it must be due to good results and to high-quality governance arrangements, not to practices or rules aimed at hindering the entry of new shareholders. Less fragmented share ownership can strengthen the assessment of the performance of directors; the principle of one person, one vote can remain a salient feature of small cooperative and mutual banks. For these reasons, as I have argued on earlier occasions, it is desirable for large cooperative banks to adopt legal forms open to assessment by the market. BIS central bankers’ speeches Banking foundations should have diversified their portfolios to reduce their dependence on the results of their reference bank. Some have not done so, they will have to adapt, taking market conditions into account. All of them must be careful not to interfere in banks’ corporate structures and their business decisions, not to hinder the necessary renewal of governing bodies, and not to influence directors’ choices on the basis of criteria other than experience and competence. Transfers from the top of foundations to the top of banks must be avoided. Prompt and significant progress is needed on these fronts. Banking Union Banking Union is a milestone in the completion of the European Union. The Single Supervisory Mechanism, comprising the ECB and the national authorities, constitutes the first element. It will be accompanied by a single mechanism for the resolution of banking crises and a harmonized system of deposit insurance, both of which are essential to align supervisory responsibility with crisis management and resolution, in order to sever the link between sovereign borrowers and banks. Work on these fronts needs to be accelerated. The Single Supervisory Mechanism is expected to be operational in November 2014, one year after the entry into force of the relevant regulation. It is a vast innovation that will require a complex organizational effort at least equal to that needed to introduce the single currency. The delicate start-up phase is taking huge investments in human resources and technical infrastructure. The preparatory work is proceeding with the maximum possible speed; the workloads of national supervisors will grow with the need to harmonize systems which are very different. In November, the ECB will launch a comprehensive assessment of the situation of the banks that will be supervised centrally (of which 15 are Italian); these banks’ assets represent 85 per cent of the euro-area banking system total. The exercise is a prerequisite for the coming into operation of the Single Supervisory Mechanism and will last twelve months; it will be carried out in collaboration with the national authorities and with the support of independent third parties. The evaluation includes three closely interlinked elements: a preliminary analysis of the banks’ risk profiles, an examination of the quality of their assets and a stress test. It will be carried out using as a benchmark a ratio of 8 per cent between the banks’ highest quality capital (defined on the basis of the rules that will be introduced next year) and their riskweighted assets. This is a threshold that ensures the availability of sufficient resources to cope with possible difficulties. The ECB and the EBA will conduct the stress test in close collaboration. The methods and scenarios to be used for this exercise will be agreed and announced at a later time. Prior to conducting the stress test, in fact, it is necessary that the results of the asset quality review are suitably incorporated into the banks’ financial statements. The assessment is a critical juncture in the management of the crisis in the euro area and in European integration. It represents a fundamental exercise of transparency, designed to strengthen confidence in the banks’ soundness and reliability and, where necessary, define the appropriate corrective measures. It will be conducted rigorously, guaranteeing absolutely equal treatment of all banks, which are now subject to highly heterogeneous supervisory systems and accounting practices. The definition of non-performing exposures used will be that recently adopted by the EBA, which is in line with the one used in Italy. Where data are lacking, estimates will be employed. The analysis will cover all types of risk and be based on current prudential rules. The risks of highly opaque instruments will be assessed with special care. Account will be taken of the diversity of methods by which banks using internal rating models calculate risk-weighted assets. The methodology of the exercise will be clearly explained, and the market will be informed of the results and supplied with the information needed to evaluate them properly. The BIS central bankers’ speeches involvement of outside experts, avoiding potential conflicts of interest, will enhance the credibility of the exercise. Together with the results of the assessment, the corrective measures required will also be specified. Any capital shortfalls will have to be made good primarily by drawing on banks’ own resources, not distributing dividends, selling non-strategic assets, and curbing costs. Where necessary, fresh capital will have to be raised on the market. The success of the exercise depends crucially on having adequate national financial backstops, to be utilized in conformity with European rules and the legal framework defined by national constitutions for the ultimate purpose of ensuring financial stability. Once the system is fully phased in, the rules for the operation of a European backstop will be defined, to avoid a situation in which measures taken at national level could reaggravate the vicious circle between sovereign risk and national credit market conditions. At present the European Stability Mechanism cannot directly recapitalize banks; its funds can be used indirectly for loans to member states. These loans, however, would increase their public debt. Direct intervention is envisaged only once the Single Supervisory Mechanism is fully operational. The implementing details are now being finalized. * * * The problems of the Italian economy stem from long-neglected structural weaknesses. They have been exacerbated by the global financial crisis and the European sovereign debt crisis. The reform action undertaken in the last two years must be continued resolutely and set within a comprehensive framework, giving Italian citizens and domestic and foreign investors alike the prospect of a country that can change and return to growth. The efficient allocation of savings is a necessary condition for our economy to regain the path of sustained, balanced growth. It requires a vital financial system that can support entrepreneurial initiative and innovation and fuel a virtuous circle between economic growth and saving. The banks have a decisive role to play. The Bank of Italy’s supervisory action – which we perform in full observance of our powers and duties under the law – is directed to protecting the savings of depositors and investors, to ensuring that their use is not distorted by inappropriate corporate structures or misplaced local allegiance. But rules and controls are no substitute for conduct guided by the principles of correctness and transparency, which banks must also ensure through a suitable internal organization. The exceptional monetary policy measures taken by the ECB Governing Council during the crisis, and even before that the supervisory action of the Bank of Italy, have protected the banks and the real economy against potentially catastrophic consequences. They have helped to preserve the confidence of savers and investors. Banking Union, in the framework of the broader process of completion of the European Union, can further stabilize conditions in European markets if it is instituted rigorously and in its entirety. It will help to safeguard savings by countering the sovereign risk component engendered by fears of euro reversibility. Italy’s banks are feeling the repercussions of a financial and economic crisis for which they bear no responsibility. But they are also suffering the consequences of slowness or failure to adapt their business operations, efficiency, service quality and organization to the evolution of the markets. They must continue to do their part with a courageous effort of renovation. BIS central bankers’ speeches | bank of italy | 2,013 | 11 |
Speech by Mr Salvatore Rossi, Deputy Governor of the Bank of Italy, at the LBMA/LPPM Precious Metals Conference 2013, Rome, 30 September 2013. | Salvatore Rossi: Post-crisis challenges to central bank independence Speech by Mr Salvatore Rossi, Deputy Governor of the Bank of Italy, at the LBMA/LPPM Precious Metals Conference 2013, Rome, 30 September 2013. * * * First, let me thank the London Bullion Market Association and the organizers of this conference for their invitation to take part in such an important event. I was asked to speak about “post-crisis challenges to central bank independence”. This is certainly a key issue, especially in these particular days. My speech will draw on some of the recent work of my colleagues at the Bank of Italy, and in particular from Franco Passacantando’s remarks at the World Bank last April on a similar topic.1 Central bank independence yesterday and today2 Over the past two centuries reflection on the nature of central banks has been incessant, proceeding hand-in-hand with the spread of these peculiar institutions. Today, nearly every country has a central bank, but scholarly opinions still differ over the actual needs that central banks were intended to address. Whatever these needs and whatever the circumstances, however, independence has been almost universally considered as the economic and legal heart of central banking. The idea that paper money must be issued by an institution that is independent and distinct from the sovereign is an ancient one: explicit and still highly topical passages were penned two centuries ago by Henry Thornton and David Ricardo. Though contested occasionally by advocates of all-embracing political sovereignty, this idea became rooted in economic thought and was incorporated, in varying ways and to varying extent, in the statutes of many central banks. In the 1980s monetary theory “rediscovered” the independence of central banks. Economists, politicians and ordinary citizens had been frightened by the inflation of the 1970s, and also highly impressed by the differing ability of the leading countries to quell it. A special strain of economic literature emerged as part of the broader theoretical school of “new classical macroeconomics” associated with Robert Lucas and Thomas Sargent. It was based on the concept of “time consistency” of economic policy, i.e. the idea that if a policy is to be credible in the eyes of private agents with rational expectations, it must be consistent over time. Since policy-makers may have incentives to deviate from their policies, some sort of institutional straitjacket is required to constrain them to time consistency. The theory quickly came to be applied to monetary policy. It was argued that the only way to prevent policy-makers from exploiting the short-run trade-off between output and inflation and so to preserve price stability was to delegate the conduct of monetary policy permanently to an independent central bank. This line of thought, lately labeled the “Jackson Hole consensus,”3 exerted a profound influence on the reform, or initial design, of a number of old and new monetary institutions, Franco Passacantando, “Challenging Times for Central Bank Independence”, http://www.bancaditalia.it/ interventi/altri_int/2013/Passacantando_23042013.pdf, April 2013. Based in part on Salvatore Rossi and Eugenio Gaiotti, “Theoretical and institutional evolution in economic policy: the case of monetary regime change in Italy in the early 1980s”, Storia del Pensiero Economico, 2004. The tenets of the Jackson Hole consensus are summarized in C. Bean et al., “Monetary Policy after the Fall”, Federal Reserve Bank of Kansas City Annual Conference, Jackson Hole, Wyoming, August 2010. See also Robert Barro and David Gordon. “Rules, Discretion, and Reputation in a Model of Monetary Policy”, Journal of Monetary Economics, July 1983, pp. 101–22; Alberto Alesina and Lawrence H. Summers, “Central Bank BIS central bankers’ speeches first and foremost the European System of Central Banks. No one would have questioned it until the outbreak of the global financial crisis and the ensuing Great Recession. Challenges from policies for financial stability Now, in the post-crisis era, the independence of central banks may be threatened first of all by their increasingly important role in the pursuit of financial stability. Until five years ago the vast majority of agents and commentators in the advanced world had never actually seen a systemic financial crisis; what knowledge of them they had came from history books. Almost everyone was firmly convinced that in advanced economies with welldeveloped financial markets the optimal course of action for central banks was to sit on the fence and then “mop up” after a financial bubble had burst. Five years after the collapse of Lehman Brothers, however, nobody still thinks that a “mop-up” strategy alone can be the best approach. The monetary policy authorities simply cannot ignore financial stability. Price stability and financial stability are now seen to be complementary objectives: the achievement of one not only facilitates but actually requires the attainment of the other. Any short-term trade-off between them can be attenuated by macroprudential action.4 Indeed, preventing the build-up of systemic risk through the use of both microprudential and macroprudential regulation and supervision is among the tasks assigned to central banks. How deeply the central bank should be involved in such matters remains an open question, however. There are naturally pros and cons, but in speculating on the issue, in my view one crucial fact must be borne in mind: financial instability can impair the transmission of monetary policy and prevent the central bank from achieving its price stability objective. This risk materialized in the euro area with the sovereign debt crisis. There are other fundamental arguments for central banks being fully involved in banking regulation and supervision. First of all their lender-of-last-resort function: only supervisory powers can enable the central bank to determine correctly and promptly whether a bank is illiquid or insolvent, as the Northern Rock case in the UK made dramatically clear in 2007.5 At the same time, putting more power in the hands of central banks is likely to increase the political pressure on them. And this is a serious challenge for these venerable institutions. Influencing asset prices and credit flows throughout the financial system makes them the perfect target for both lobbies and governments – and, of course, the ideal culprit if things go wrong. It was argued in the past that an institution in charge of both monetary policy and banking supervision may be tempted to be softer in setting the monetary stance in order to avert a banking crisis. The global financial crisis has dispelled this argument. On the other hand, the historical experience of countries like Italy, where monetary policy and banking supervision were concentrated in a single institution – the central bank – shows that the independence attributed to the two functions by law and by social norms tends to be mutually reinforcing when the two are put under the same roof. The monetary-policy independence of a central bank – enshrined in statute, confirmed in practice and strengthened by hard-earned reputation – can powerfully support the independence of Independence and Macroeconomic Performance: Some Comparative Evidence,” Journal of Money, Credit and Banking, Vol. 25, No. 2, May 1993, pp. 151–162. Paolo Angelini et al. “Monetary and Macroprudential Policies,” Banca d’Italia Working 5 Papers, No. 801, March 2011. BIS, Central bank governance and financial stability, May 2011. BIS central bankers’ speeches banking supervision, which is essential to its effectiveness according to international principles.6 Another challenge to central bank independence comes from the resolution of banks that are no longer viable. If the central bank is in charge of banking supervision it obviously cannot abstract from bank resolution. But more often than not resolving a bank implies the use of taxpayers’ money, and a non-elected institution dealing with it may find itself in an uncomfortable position, unless proper institutional arrangements are in place. This is why the Banking Union in Europe is not a threat to central bank independence. A well-designed Banking Union will break the perverse feedback loop between sovereigns and banks, not undermining but strengthening the independence of the ECB and the national supervisory authorities. The Banking Union must contain both ingredients: a single supervisory mechanism and a single resolution mechanism, flanked by a single deposit insurance scheme. The recent proposal by the European Commission points precisely in that direction.7 The Banking Union will be an important step towards the completion of fully integrated European Union. Challenges from unconventional monetary operations The global financial crisis prompted central banks in most of the advanced countries to adopt a wide range of unconventional monetary measures, ranging from purchases of public and private assets to currency swaps and much more. While these measures undoubtedly avoided the collapse of the financial system and a devastating depression, in the perception of public opinion there was, and there still is, a risk of undesirable side-effects. Compared to standard monetary instruments, unconventional operations may have substantial fiscal and re-distributional effects. A technocratic institution engaging in such operations may be perceived as lacking in democratic legitimacy, and its independence may be challenged. In a democracy the constant support of public opinion is the ultimate safeguard for a central bank. On this, I would like to quote Paul Volcker: In concept and practice, an informed citizenry, acting through a constitutional process and its elected representatives, can and does assign certain of its sovereign powers to a duly constituted authority. The corollary of that provision is also relevant: that delegation of authority can be withdrawn. In other words, the exercise of important governmental powers is ultimately dependent on maintaining the consent of the body politic.8 Central banks must accordingly pay increasingly close attention to defining and explaining the objectives of their action. Communication to the public and to political institutions is far more important today than in the past. Another possible unintended consequence of unconventional monetary policies is fiscal dominance. It is sometimes argued that large-scale purchases of government bonds by the central bank could blur the distinction between fiscal policy and monetary policy and so undermine central bank autonomy, which rests on the Ricardian notion of separation between the power to create money and the government’s power to spend it. But in gauging Independence is also a requirement for the supervisor, as is stated in the IMF’s Financial Sector Assessment Program: “The supervisor possesses operational independence, transparent processes, sound governance, budgetary processes that do not undermine autonomy and adequate resources, and is accountable for the discharge of its duties and use of its resources.” European Commission, COM/2013/520/FINAL, July 2013. Paul Volcker, Il centenario della Banca d’Italia, (Milan, Libri Scheiwiller, 1994), p. 126. BIS central bankers’ speeches the risk that a central bank making unconventional bond purchases is actually creating money to finance the public sector, one must attentively consider motivations and institutional safeguards.9 In the 1970s a number of central banks, including the Bank of Italy, acted as buyers of last resort of government bonds on the primary market. In that case there was no possible doubt that among the central bank’s motivations price stability had a good deal less importance than other, more properly governmental objectives, or that institutional safeguards were scant. Italy eliminated these anomalies in 1980 with what was dubbed the “divorce” between the Treasury and the Bank of Italy. Today, by contrast, it is clear that the Fed and the ECB, which have both made substantial recourse to unconventional measures, though differing in scale and modalities, were simply pursuing their own statutory objectives, by providing stimulus when shortterm interest rates were at the zero lower bound or by restoring the viability of the monetary policy transmission mechanism. Future exit, when it is decided (but it is not yet time in the euro area, as the President of the ECB has recently made clear), will have to be cautious not only for macroeconomic reasons but also in order to reduce the risks to financial stability. Cooperation among central banks will be crucial, as it was in other phases of the global financial crisis. Challenges from asset management Financial autonomy is an essential pillar of central bank independence. The unconventional measures have expanded central banks’ balance sheets enormously; the exposure to risk inherent in these asset purchases has increased accordingly. Central banks need to preserve their loss absorption capacity, but the very fact of suffering protracted financial losses, even though the reserves remain ample and can easily absorb them, implies reputational risks that could undermine the confidence of the public in the central bank’s ability to deliver on policy targets, and could lead to government interference.10 Central banks have deployed a broad set of tools to safeguard their financial autonomy and credibility. However, the objectives of portfolio management for pure investment purposes and for monetary policy functions may conflict with one another, especially in times of financial turmoil. For instance, the liquidation of assets in order to reduce the risk of the investment portfolio may exacerbate market stress and be procyclical from the monetary policy standpoint. In order to deal with procyclicality, risk management techniques should focus on longer time horizons and be extended to the central bank’s entire balance sheet. This is one of the main recommendations of the IMF’s new Reserve Management Guidelines published in April 2013.11 Probably the most common response is diversification. Foreign reserve managers are increasingly interested in market segments and currencies that until recently would not have been considered. The value of central banks’ foreign assets other than gold has now reached $11 trillion, roughly 15% of world GDP. I don’t need to remind you of the special role that gold plays in central banks’ official reserves. Not only does it have the valuable characteristic of allowing diversification, in Eugenio Gaiotti and Alessandro Secchi, “Monetary Policy and Fiscal Dominance in Italy from the 1970s to the adoption of the euro,” Banca d’Italia Occasional Papers, No. 141, November 2012. David. Archer and Paul Moser-Boehm, “Central bank finances,” BIS Papers, No. 71, April 2013. IMF, Revised Guidelines for Foreign Exchange Reserve Management, February 2013. BIS central bankers’ speeches particular when financial markets are highly integrated. In addition it is unique among safe assets owing to the fact that it is not “issued” by any government or central bank, so its value cannot be influenced by political decisions or by the solvency of any institution. These features, coupled with historical, political and psychological reasons, tell in favour of gold’s importance as a component of central bank reserves, both in developed and in emerging countries. As an element that enhances the resilience of reserves to abrupt falls in value in times of stress, gold underpins the independence of central banks and their ability to act as the ultimate guarantor of domestic financial stability. Conclusion One lesson the history of central banking is teaching us, applicable to the precrisis years of the “great moderation” as well as to the Great Recession, is that monetary policy works better when it follows a well-defined strategy, since the economy feeds on both its current and its expected future stance. To attenuate time inconsistency, central banks need to be independent but at the same time accountable and transparent. These two requisites are mutually self-reinforcing: a well-defined strategy implies greater transparency and accountability, and viceversa. The Outright Monetary Transactions announced by the ECB Governing Council last September are an excellent case in point. Communication was essential: we had to explain that the OMTs were legitimate and compatible with the Treaty, since their aim was to preserve the functionality of markets and thus restore the monetary policy transmission mechanism. The conditionality and enforcement mechanisms were such as to prevent moral hazard for both borrowers and investors. Effective communication and the sound design of the programme helped to confirm the regime of monetary dominance that is at the heart of the Treaty.12 Had OMTs been considered the prelude to debt monetization and the loss of independence by the Eurosystem, the market reaction would have been dire indeed; instead, it was promptly positive. Why are clear strategies, transparency and accountability crucial? Because they are the key features of the most valuable asset that a central bank can produce: trust.13 Ultimately, a central bank’s independence is in jeopardy when it no longer satisfies the public need for trust. Ignazio Visco, Governor of the Bank of Italy, in a recent lecture at the Imperial College in London quoted Curzio Giannini, a brilliant Bank of Italy economist who passed away prematurely nine years ago, who said: “The legitimacy of central banks does not lie in their policy activism, or the ability to generate income, or even […] their efficiency. Rather, […] it derives from competence, moderation, the long-term approach, and the refusal to take any tasks beyond their primary role”.14 In August 2012, in London, a central banker said: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough”. A few days later the Governing Council of the ECB decided to launch OMTs. The public believed them. They had produced trust. Benoît Cœuré, Outright Monetary Transactions, one year on, http://www.ecb.europa.eu/press/key/ date/2013/html/sp130902.en.html, September 2013. Ignazio Visco, “The Financial Sector after the Crisis”, 5 March 2013, http://www.bancaditalia.it/interventi/ integov/2013/05032013/Visco_05032013.pdf. Curzio Giannini, The Age of Central Banks, Cheltenham, UK, Edward Elgar, 2011, pp. 258–59. BIS central bankers’ speeches | bank of italy | 2,013 | 11 |
Opening remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Conference on "Money and monetary institutions after the crisis", in memory of Curzio Giannini, Bank of Italy, Rome, 10 December 2013. | Ignazio Visco: Money and monetary institutions after the crisis Opening remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Conference on “Money and monetary institutions after the crisis”, in memory of Curzio Giannini, Bank of Italy, Rome, 10 December 2013. * * * It is my pleasure to welcome you all here today at this conference on Money and monetary institutions after the crisis. Key aspects of the evolution of money and monetary institutions had been identified more than ten years ago by Curzio Giannini, a brilliant Banca d’Italia economist who was a dedicated scholar of central banking and died in July 2003 at the age of 45, in a book on The age of central banks.1 This conference is held in his memory. In the final pages of his contribution he wrote: In the years to come, the most interesting developments will probably be precisely in the sphere of supervision and regulation. […] Whatever its detractors may say, the central bank has no need to move into new lines of business. Capitalism generated the central bank and capitalism will come to it again, even if the current infatuation with the financial markets’ self-regulating capacity were to endure. Indeed, the financial crisis has led to a generalized collapse in the confidence of such selfregulating capacity. Central banks have had to profoundly innovate their instruments of intervention by introducing liquidity-providing operations of unlimited quantity, unusually long maturity and at exceptionally low interest rates, also through currency swaps and with respect to non-bank counterparties; they also engaged in large purchases of public and private securities. The domestic and supranational institutional frameworks have been greatly modified. The crisis has prompted several relevant changes in the IMF lending framework in terms of additional financial resources, new financing facilities and cooperation with euro-area institutions; its surveillance is conducted within an enhanced legal framework and has become more attentive to international spillovers; ongoing governance reforms are further strengthening its legitimacy and effectiveness. In many jurisdictions central banks have been given stronger supervisory powers and new bodies in charge of macro-prudential supervision have been created. The most profound wave of institutional innovation took place in Europe, where the sovereign debt crisis generated a leap forward in the process of unification. I am convinced that Curzio Giannini’s analyses can facilitate the interpretation of the problems that we are facing today and can offer guidance to frame our discussions on the institutional evolution of central banking in rigorous terms. This is indeed one of the main reasons why we decided to organize this conference. One of Curzio’s distinctive qualities was the ability to grasp the essence of the issues he dealt with, among which the complex relationship between the evolution of central banks as institutions and as economic, historical, social and political developments. This was the result of his passion for research, his intellectual brilliance, the multidisciplinary nature of his interests. During the years he worked at the Research Department of Banca d’Italia, he dealt with the reforms of Italy’s monetary institutions in the 1980s and 1990s, European monetary integration, financial market regulation. He was involved in a number of initiatives concerning payment system issues, which helped him greatly to forge his ideas about central banking, and paid great attention to international relations, in particular to the role and functioning of the International Monetary Fund. C. Giannini, L’età delle banche centrali, Bologna, Il Mulino, 2004. English translation, The age of central banks, Edward Elgar, Cheltenham, UK, 2011, p. 255 and pp. 258–59. BIS central bankers’ speeches Giannini’s basic thesis is that central banks are the outcome of a gradual institutional evolution, the rationale of which resides in money’s distinctive features compared with other goods and services. This evolution is not deterministic but path-dependent, correlated with the historical evolution of our political, social and economic systems. It depends largely on the fact that if money is to survive and perform its functions in economic transactions effectively in space and time, it must instil and maintain a sufficient degree of confidence in its acceptability and future value. The role and the powers of central banks – indeed their very existence – derive from the ultimate purpose of sustaining that confidence. Interestingly, Giannini is convinced that innovation in central banking is prompted more by deflationary than by inflationary pressures and by the need to cope with financial stability problems. This approach allowed him to foresee key issues, strictly related to the themes that will be covered in the four sessions of this conference: the relation between price stability and financial stability and the interaction between monetary policy and macro- and microprudential policies; central bank independence and the changing relationship with government, in light of the recent massive expansion of central banks’ balance sheets; the evolution of money and payment systems, and whether we are witnessing a new phase of changes in the forms and the use of money; supranational money management issues and the problems related to the international lender of last resort function. For each of these themes, Giannini’s works provide a great deal of evidence of his extraordinary foresight. For instance in the early 2000s he had already clearly anticipated the risk that too narrow a focus on price stability could deflect economists’ and policymakers’ attention from the importance of the banking system as the transmission belt of monetary policy. He was also aware of the difficulty in replicating typical central banking functions, such as lending of last resort, at an international level (e.g. the International Monetary Fund) and with respect to sovereign borrowers. Or that a monetary union also requires a banking union, and this in turn calls for a greater degree of political integration. Or that an area that was often neglected, that of an international framework for debt restructurings, would soon need to be addressed. °°° Today, discussing the role of central banks, their independence, and their relationships with other economic and financial authorities has again become an issue of the utmost importance. The idea that the central bank’s role must encompass a plurality of functions related to one another, at the core of many of Curzio Giannini’s analyses, has gained growing consent: not only in the field of monetary policy and the management of the payments system, but also for macro- and micro-prudential supervision. This coexistence of tasks has historically characterized the Bank of Italy, and since the onset of the crisis it is becoming more and more of a feature for many central banks worldwide. Central banks conduct monetary policy to achieve the objective of price stability – in most cases their primary goal – which in turn fosters broader macroeconomic stability. But central banks also have responsibilities in the area of financial stability: this is indeed a key precondition for price stability. Following the crisis, greater attention is being devoted to the interactions and possible conflicts between policies addressed to maintain, respectively, price and financial stability. For example, in the current crisis, “unconventional” measures have been used to address dysfunctional liquidity markets and banks’ reluctance to lend. In many cases, central banks had no choice but to move into unchartered waters, so as to limit the consequences of inadequate institutional or regulatory frameworks, imprudent behaviour in the private sector or national governments’ flawed fiscal policies. Only institutional reforms and fiscal policy adjustments can avoid overburdening central banks with an excessive workload. The sovereign debt crisis in the euro area is a clear example of a situation in which disentangling price and financial stability issues became virtually impossible, and in which the role of the central bank as a guardian of trust was crucial. The unconventional measures BIS central bankers’ speeches adopted by the Governing Council of the European Central Bank were actually aimed at countering distortions in financial markets and self-fulfilling debt runs which threatened the correct transmission of the Eurosystem monetary policy and, ultimately, its ability to pursue the primary objective of price stability. The need for these measures arose, to a large extent, from fundamental weaknesses in the European institutional design and from delays or mistakes in the response to the crisis. The announcement of the involvement of private investors in the restructuring of the Greek debt in the summer of 2011 made financial markets fully aware of the implications of the prohibition to intervene to rescue member states under the Treaty on the Functioning of the European Union. This triggered a further worsening of sovereign risk assessments and led to a very serious crisis of confidence in the ability of the single currency to survive. The crisis became systemic; the yield spreads between the government bonds of the countries under stress and German bonds rose dramatically. On this, again, Curzio’s foresight is most remarkable: ten years before the sovereign debt crisis he had identified several of the key features that have characterized the situation as it actually unfolded:2 The inevitable complexities of political decision making create the possibility of a self-fulfilling debt run, while the fundamental information asymmetry between national authorities, on the one hand, and multilateral organizations and private creditors, on the other, works against the creation of a climate of trust once a crisis emerges, and might even stand in the way of mobilizing public support for the government’s program. The European institutional weaknesses were clearly reflected in financial markets’ risk assessment. The sovereign spreads came to be determined by two factors, one national and one European, linked respectively to the flaws of certain countries’ economies and public finances (sustainability risk), and to the incompleteness of European construction and the attendant fears of a break-up of the monetary union (redenomination risk). In July 2012 the yield differential between the 10-year Italian BTPs and the equivalent German Bunds was again just over 500 bps, compared with a value of about 200 bps estimated to be consistent with Italian and German economic fundamentals. The response to the sovereign debt crisis has thus been two-pronged: individual countries have pledged to adopt prudent budgetary policies and structural reforms to support competitiveness; a far-reaching reform of EU economic governance has been undertaken, backed by political commitment to strengthen the Union. But the time needed to implement Europe’s complex strategy to counter the economic crisis will necessarily be long. Distortions and fragmentation in financial markets can in the meantime undermine the transmission of monetary policy and jeopardize the entire process. This has led to the ECB stepping in with emergency unconventional measures, thus providing a “bridge”. The ECB Governing Council’s decision to announce the Outright Monetary Transactions in the summer of 2012 was a response to these dangers. The announcement, an unmistakeable signal of the determination to preserve the euro, reversed the spiral of pessimism at a crucial juncture. By restoring confidence, it produced immediate benefits: as a result of a sharp reduction in the redenomination risks, medium and long-term yields in the countries under pressure decreased and the fragmentation of markets along national borders was attenuated. In the presence of a credible and firm action to restore market confidence, there is no need to actually use the new instrument. But the complete elimination of the redenomination risk can only be achieved if sustained progress is made in the euro-area’s economic fundamentals and in the process towards a fully fledged European Union. Discussion on budgetary and political union must be followed by concrete action. Curzio Giannini, Pitfalls in international crisis lending, in Charles Goodhart and Gerhard Illing (eds.), Financial crises, contagion and the lender of last resort: A reader, Oxford University Press, 2002, p. 521. BIS central bankers’ speeches The recourse to unconventional measures by major central banks and the expansion of their balance sheets have been justified by the severity of the crisis. Central banks’ unprecedented activism has raised new issues, giving rise to a debate that not only encompasses technical aspects, notably how to exit these measures and normalize monetary policy, but at times touches upon key institutional aspects such as independence of central banks. For example, it has been argued that central bank independence in the pursuit of price stability may be incompatible with an active use of unconventional measures in response to the financial and sovereign debt crisis. It is also feared that an active use of central banks’ balance sheets would blur the boundaries between monetary and fiscal policies. The new challenges to central bank independence arise as a consequence of prolonged monetary policy accommodation: at the current juncture central banks could be unduly constrained in their choices about the timing and pace of policy normalization by pressure arising both from financial markets that have become overly dependent on their support and from unrealistic expectations about what central banks can deliver. On these issues, the jury is still out. More in general, the crisis has raised the question of whether central banks should revise their objectives or strategies. In my view there is no need to question the current objectives of monetary policy; in the case of the Eurosystem, that of preserving (medium term) price stability. I do not believe that there is a particular need for financial stability to become an explicit objective of monetary policy on a par with price stability. Indeed, the benefits of our monetary framework have become more, not less, evident during the crisis, with inflation expectations remaining well-anchored throughout. Also, assigning financial stability as an explicit additional objective to monetary policy could risk blurring responsibilities and creating potential conflicts. However, I believe that there is no question that preserving financial stability is a crucial albeit not exclusive responsibility of central banks. Indeed, the crisis has not put into question the idea that over longer horizons there is no trade-off between price stability and financial stability objectives – rather, there are synergies. °°° The crisis has thus rekindled the long-standing debate on whether central banks should act pre-emptively against signs of financial instability that can morph into systemic risks. A broad consensus has indeed emerged on the idea that macro-prudential policies should be adopted to limit these risks. These policies would address both the cross-sectional dimension of the financial system, with the aim of strengthening its resilience to adverse real or financial shocks, and its temporal dimension, to contain the accumulation of risk over the business or financial cycle. Furthermore, countercyclical macro-prudential policies moderating the financial cycle would support monetary policy in the stabilisation of the economy and, by adding a systemic perspective, they would complement micro-prudential policies directed at preserving the stability of individual financial intermediaries. However, a potential for conflicts, or what economists usually refer to as tradeoffs, may arise between monetary, macro- and micro-prudential policies. It could, for instance, materialise during downturns, when the macro-prudential regulator may want to release equity buffers in order to avoid a credit crunch, whereas the micro-prudential regulator may be reluctant to let that happen owing to the need to preserve the safety and soundness of individual institutions. Different institutional settings can be envisaged to solve these conflicts. Some have argued that the best way would be to allocate different policies to different authorities. However, given the strict complementarities between monetary, macro- and micro-prudential policies, a view is emerging – which I share – that central banks are best positioned to offer effective solutions. Conversely, there is broad agreement that resolution mechanisms to resolve financial intermediaries must be located outside central banks, most notably because resolution decisions may involve the use of public money. Even if it would be appropriate for resolution and supervision to be separated, close cooperation and information sharing should BIS central bankers’ speeches be obviously in place, not the least to better identify proper forms of recovery, as in several cases the issue is not just one of outright bank liquidation. In any event, the broadening of central banks’ tasks requires that their independence in the pursuing of financial stability is ensured to the same extent as for the conduct of monetary policy. All this is particularly clear in a currency union, where distinctive challenges come from the involvement of a plurality of institutions. In the euro area, price stability is an area-wide objective targeted by the Eurosystem’s single monetary policy. However, financial imbalances can take on a country-specific dimension, so that macro-and micro-prudential policies can be adopted by national authorities. Tradeoffs may arise and therefore there is a need for the coordination of national policies when financial instability gives rise to area-wide (systemic) risks. The recognition and understanding of these interactions and tradeoffs help in driving decisions about the institutional setting for policy-making. The Regulation establishing the Single Supervisory Mechanism, also involving the National Competent Authorities, assigns to the ECB not only micro-prudential tasks but also specific roles for macro-prudential policy, notably the implementation of macro-prudential measures set out in EU legislation. The ECB thus provides a concrete case of an institutional setting aimed at best exploiting the complementarities between monetary, macro-prudential and micro-prudential policies while addressing possible interactions and tradeoffs; at the same time care will be taken to ensure a clear functional and operational separation of these policies within the institution and the system. The setting should also ensure the muchneeded euro area-wide coordination in the application of these policies, so as to adequately address potential spill-over effects. °°° In the euro area the institutional changes resulting from the crisis are exerting a major impact on both the ECB and the national central banks, whose scope is no less important than the one arising from the introduction of the euro. Regardless of the specific innovations in their institutional settings, operations and tools, ultimately the main task of central banks is to produce trust. This consideration comes from the heart of Curzio Giannini’s work, the final sentences of which are indeed very telling: The central bank produces an intangible but essential good – trust – of which capitalism (based as it is on a pyramid of paper if not mere electronic signals) has an immense need. We must not forget that trust, or its synonym “confidence”, derives from the Latin fides, meaning faith, which cannot be produced simply by contract. In fact the legitimacy of central banks does not lie in their policy activism, or the ability to generate income, or even, save in a highly indirect sense, their efficiency. Rather, […] it derives from competence, moderation, the long-term approach, and the refusal to take any tasks beyond their primary role. If, as I am sure, there is another phase in the development of central banking, it will spring from these values. BIS central bankers’ speeches | bank of italy | 2,013 | 12 |
Welcoming address by Mr Fabio Panetta, Deputy Director General of the Bank of Italy, at the SEPA Conference, organized by the Bank of Italy, Rome, 9 December 2013. | Fabio Panetta: SEPA and its repercussions for Italy’s payment system Welcoming address by Mr Fabio Panetta, Deputy Director General of the Bank of Italy, at the SEPA Conference, organized by the Bank of Italy, Rome, 9 December 2013. * * * I would like to thank all the authorities, market players, associations and analysts for taking part in today’s meeting. SEPA plays a key role in the completion of the European financial system, by ensuring the provision of innovative, reliable and affordable payment services to market players and users. National and European authorities, the banking and financial sector, trade and consumer associations, and the public sector are all involved in the project. The Bank of Italy has committed resources and energies to drive this innovation forward. SEPA plays a major role in European integration, involving as it does a myriad of stakeholders representing very different activities, interests and levels of technological development. The objective is not just to introduce new payment schemes and new procedures, for the project will also bring about positive changes in the habits of European citizens and in the organization and work methods of banks, firms and the public sector. Although considerable progress has been made in recent months, much remains to be done. The project must continue to advance apace, if necessary with a sharp spurt in the last furlong, which will probably also be the most arduous. The work already completed and the results achieved to date justify a cautious optimism in view of the end date of 1 February 2014. The SEPA is important on two levels: it heightens integration and competition in the retail payment market and it fosters an efficient and reliable payment system. These objectives are shared by the authorities and business milieus. The structure of the project, its aims and benefits are clearly and exhaustively described in the publication the Bank has distributed today;1 the areas covered range from the standardization of credit transfers and direct debits to the adoption of harmonized schemes for payment cards. The technical solutions adopted in the past at the national level are being adapted to the new SEPA framework within clearly defined limits in order to avoid perpetuating the fragmentation among member states. The context in which SEPA operates is based on two key elements for the evolution of the payment system: legislation and technology. Harmonized European legislation on payments, centred around the Payment Services Directive (PSD), is fundamental for the success of SEPA. The proposed new Directive, PSD2, will further converge national legislation and boost competition in the market for payment services, improving the transparency and reliability of the products offered to firms and the public. By standardizing the payment instruments made available by SEPA and employing advanced technology for e-commerce and mobile and Internet communications it will be possible to create a more modern payment market, in line with European and Italian policies to increase the spread of information technology. SEPA will bring substantial benefits to all concerned. Firms will be able to make and receive payments via a single account at any European bank. Using the ISO standard, which can be See “La SEPA e i suoi riflessi sul sistema dei pagamenti italiano”, Tematiche istituzionali, Banca d’Italia, November 2013 (http://www.bancaditalia.it/pubblicazioni/temist/sepa-riflessi-sistema-pagamenti/testo.pdf). BIS central bankers’ speeches integrated with banks’ own management software, will foster innovation in several ways, from integrating the collection process to rationalizing accounting procedures. There will be significant advantages for small firms as well. SEPA will also facilitate the use of Internet and innovative communication systems such as tablets and smartphones, offering consumers flexibility in the use of different means of payment at low costs. Users’ payments and collections with firms and the public sector will improve with the use of electronic instruments. From the banks’ point of view, retail payment services not only account for a large part of total expenditure and revenue,2 but they are an important route to customer loyalty through the provision of high-quality services at affordable prices. Although European market integration may entail a loss of position in the very short term, in a longer perspective it will enlarge the potential supply and open the way for advanced technology products. Similar benefits await non-bank providers of payment services and managers of retail payment systems who are called on to create a Europe-wide network. I would like to make a final comment on the importance of SEPA for Italy. Non-cash means of payment are used less in our country than elsewhere in Europe. Paper-based payment instruments are still widely employed, although they are more costly for issuers and less secure for users. The characteristics of the Italian market and the payment habits of the population reflect the structural characteristics of the productive system, such as the limited use of more advanced means of communication, the small average size of commercial firms, and the rigidity in the supply of innovative services. In many areas of the country this backwardness is aggravated by the size of the underground economy and in some cases by widespread illegality. Modernizing Italy’s payment system and integrating it in the wider European market will bring benefits far beyond those directly deriving from the introduction of new instruments and new technical standards. The changes now under way, boosted by SEPA, will bring clarity and transparency to business relations throughout the 4 economy and not just in the payment sector. Market players will be encouraged to revise their organization and code of conduct. The public sector will have the tools and procedures they need to improve payment transactions with firms and the public. In this way, the creation of a modern, competitive and reliable payment system in Italy will help to build a more efficient and transparent productive system. In the 1990s, following the recommendations of the White Paper on Payment Systems in Italy, we successfully undertook a broad reform of interbank settlement procedures to bring the country into line with the most advanced European standards. Today, we must take the opportunity offered by SEPA to improve the supply of payment services in Italy, with benefits for the public, firms and the public sector. This is the route we should follow. I hope that this conference will yield suggestions, observations and ideas for mapping the future development of Italy’s payment system as part of the broader growth and modernization of Italy in Europe. Thank you. Payment services represent 15 per cent of banks’ total operating costs. BIS central bankers’ speeches | bank of italy | 2,013 | 12 |
Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the 20th ASSIOM FOREX (the Financial Markets Association of Italy) Congress, Rome, 8 February 2014. | Ignazio Visco: The recovery and the risks – an Italian central banker view Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the 20th ASSIOM FOREX (the Financial Markets Association of Italy) Congress, Rome, 8 February 2014. * * * The recovery and the risks Since last summer the continued strengthening of economic activity in the advanced economies, particularly the United States, has been accompanied by an improvement in financial conditions and a decline in the risk premiums on government bonds in the euro area. In Italy, net capital inflows have continued, and the Bank of Italy’s debit balance in TARGET2 has diminished by a third compared with the high point recorded in the summer of 2012. The easing of tensions in the euro area reflects the progress made in European Union governance, the resolute steering of monetary policy towards the maintenance of accommodative conditions, and the correction of national imbalances, with significant progress being made in the countries hardest hit by the crisis. Nevertheless, the risks remain high. Tensions on the international markets, which had arisen after the Federal Reserve’s initial announcement of the gradual tapering of security purchases, have returned in recent weeks, exacerbated by signs of economic slowdown in China. This has affected the emerging economies, especially those with structural problems and short-term financing difficulties. The euro-area economy has begun to grow again, but slowly and with marked differences between countries. In Italy, industrial production, which had declined in every quarter since the summer of 2011, grew by about 1 per cent in the last quarter of 2013. Since last summer, sales and orders of industrial firms have been increasing moderately and the qualitative indicators have improved steadily, pointing to a continued expansion of output in manufacturing and a move back towards growth in services as well. GDP is estimated to have increased by several tenths of a percentage point in the fourth quarter of 2013, after ceasing to fall in the third. Our latest baseline scenario put GDP growth at about three quarters of a percentage point in 2014. The recovery in sales in industry is driven by exports, which in recent years have grown in line with our outlet markets, after a lengthy period of decline in Italy’s market shares. Domestic demand, by contrast, is still struggling. Household consumption has been affected by the persistent weakness of the labour market and insufficient growth of income, as well as by the desire to bring saving back to higher levels after the decline of recent years. Given the good performance of export orders, investment should return to growth this year, but as a percentage of GDP it will remain at the lowest levels of the last twenty years. If capital formation is to show a stronger increase, the uncertainty regarding the prospects for the medium term must diminish and the credit supply tensions and the financial imbalances affecting our firms must be overcome. The recovery has not spread to all sectors of the economy, nor to all parts of the country; the improvement has mostly involved larger, more export-oriented firms located in the Centre and North. What sets the firms that continue to expand sales and jobs apart from those that are struggling to stay in the market is their ability to innovate products and processes, to compete successfully on domestic and international markets and to penetrate the most dynamic of these. The competitiveness of manufacturing firms, measured on the basis of producer prices, improved by about 4 per cent between 2007 and 2013. Unit labour costs increased more than in the other main countries of the area, mainly because of the dynamics of productivity, BIS central bankers’ speeches but this was offset by a reduction in profit margins. The gain in competitiveness in trade with non-euro-area countries due to the depreciation of the euro between 2007 and 2012 has been practically wiped out in the last year. Several contrasting factors affect the performance of exchange rates. An appreciation of the euro is favoured both by the rising surplus in the euro area’s current account and by the inflow of capital associated with the attenuation of the sovereign debt crisis. An impetus to depreciation, however, particularly against the dollar, derives from the cyclical improvement and the start of monetary tapering in the United States. In any case, the gains in competitiveness that might possibly result from changes in the exchange rate will be transient in the absence of a recovery in productivity. In the last three years, it is estimated that total factor productivity in Italy has only just recouped the loss due to the contraction of 2009, whereas in France it has grown by 1.5 per cent and in Germany by about 5 per cent. Investment per worker fell by almost 9 per cent in Italy, compared with an increase of 2 per cent in France and 8 per cent in Germany. Over the past few months the first signs of a stabilization in employment and an increase in hours worked have emerged. But the unemployment rate now nears 13 per cent, twice as high as before the crisis and the highest on record since this statistical series began to be collected in the 1950s. Given the extensive use of wage supplementation, and also considering the longer-term changes produced by technological innovation, employment runs the risk of recovering only slowly, and with a lag behind the upturn in activity. As in other countries, the protracted slump in economic activity has weighed most heavily on the young: the employment rate for young people aged between 15 and 24 years, not counting students, has fallen to 43 per cent from 61 per cent in 2007; for the 25–34 age group it has fallen from 74 to 66 per cent. Overall, the recovery still appears to be weak and uncertain. Every effort must be made, at national and European level, to increase demand by fostering, in a shared vision of clearer prospects for the future, the creation of new job opportunities, business investment, and innovation geared to achieving productivity gains to transfer to incomes. The political and social difficulties besetting this course are accompanied by the presence of some risks that need special consideration. Besides the evolving international situation, these relate to price dynamics, conditions on the sovereign debt market and access to credit. Price dynamics In recent months, inflation in the euro area and in Italy has regularly fallen by more than expected; since October, the twelve-month rise in consumer prices has stood below 1 per cent. Eurosystem projections suggest that consumer price inflation, both this year and next, will remain well below the level considered consistent with the European Central Bank’s definition of price stability, namely inflation below but close to 2 per cent over a medium-term horizon. Our forecasts paint a similar picture for the evolution of consumer prices in Italy. The deceleration of prices reflects not only the downward trend in the energy component, but also the cyclical weakness of the economy. The exceptional decline in economic activity provoked by the crisis may have heightened the sensitivity of inflation to cyclical conditions, in particular for goods other than food and energy. We are not in a situation of a generalized price reduction, of deflation. But even a prolonged period of price changes below the level compatible with monetary stability is undesirable. It hinders the correction of macroeconomic imbalances through the adjustment of relative prices. It can reduce consumers’ spending capacity and adversely affect the cost of capital for investment. Above all, the risk – limited at present – that long-term inflation expectations may become detached from price stability must not be underestimated. This is a nonlinear process, capable of materializing suddenly. BIS central bankers’ speeches For this reason, the ECB’s Governing Council has reaffirmed its intention to maintain an accommodative monetary policy stance for as long as necessary and has firmly reiterated that policy rates will remain at present or lower levels for an extended period. In line with its mandate, the Council will use all the tools needed to keep actual and expected inflation in line with the definition of price stability in the medium term. Sovereign debt The narrowing of the spread between ten-year BTPs and German Bunds to about 200 basis points, the level recorded in July 2011, reflects the abatement of the risk of a euro-area break up and strengthening market confidence. Upward pressures on global interest rates stemming from the consolidation of the recovery or from international turbulence cannot, however, be ruled out; only a return, including in Italy, to sustained growth can offset such pressures, by favouring a further reduction of the component of sovereign bond yield differentials due to different trends in the fundamentals. Hard-won confidence must not be undermined by the resurgence of fears about the determination of Italy, and of all the countries of the euro area, to continue on the path of reform and responsibility. Failure to do so would hinder the improvement of the conditions of access to credit, with inevitable repercussions on the cost of capital and investment by firms. The path ahead is a narrow one, and in taking it due consideration must certainly be accorded to the needs of those who are suffering the most as a result of the long crisis and the major changes accompanying the opening of markets and the rapid emergence of new technologies, changes for which most of the necessary structural adjustment is still incomplete. Observance of budgetary constraints does not only stem from formal obligations; it is what guarantees full access to the financial markets for the Treasury. In 2013, the public sector borrowing requirement amounted to around €80 billion. Including the rollover of maturing debt, the Treasury’s annual recourse to the markets is on the order of €400 billion. Net foreign purchases of Italian government securities, in particular by institutional investors, began to show signs of recovery in mid-2012, and continued through 2013. But the confidence of foreign investors, at times summarily dismissed as “speculators”, can be very quickly undermined by any sign of deterioration in a sovereign borrower’s creditworthiness. Between summer 2011 and spring 2012, the share of Italian government bonds in foreign hands (not counting the Eurosystem’s purchases through the Securities Markets Programme) fell by 16 percentage points to 31 per cent. Before the crisis, Italy had postponed the reduction of its structural deficit and failed to grow enough to ensure a rapid reduction of the debt-to-GDP ratio. The acceleration of the adjustment came at the most difficult moment; it has had inevitable procyclical effects, but it served the need to avoid the worst. It could not keep the debt ratio, in these years of crisis, from rising. What the European rules require is the reduction of this ratio, not of the absolute amount of the debt. In order to achieve this, even given moderate growth, it is sufficient not to deviate from the objective of structural budget balance. The credibility that Italy has regained with its efforts and its awareness that there is no alternative to proceeding along the road of reform is producing savings on interest payments, making it easier to contain the budget deficit. This credibility can allow the country to exploit the margins of flexibility envisaged by the European rules to finance public investment, and enable it to uphold, with authority, the completion of the European construction, with a view among other things to a fiscal union that makes it possible to use common resources to step up infrastructural investment and facilitate the implementation of reforms. BIS central bankers’ speeches Access to credit The decline in lending to Italian firms has continued, with a contraction of more than 9 per cent over the last two years after an expansion of nearly 14 per cent between the end of 2007 and the autumn of 2011. Against the background of an economic outlook still clouded by uncertainty, credit demand remains weak, but the supply-side tensions are obstinate as well. The responses of Italian banks to last quarter’s bank lending survey confirm the attenuation of credit restrictions; however, a large percentage of firms, especially small businesses, still report finding it difficult to obtain credit. The gap between the cost of new loans to firms in Italy and the euro-area average has narrowed – to under 80 basis points in December, from nearly 100 at the end of 2012 – but it remains wide. Banks’ liquidity has improved in the last year. Recourse to Eurosystem refinancing fell to €224 billion at the end of January 2014, €50 billion less than a year earlier. Italian banks, led by the largest ones, have repaid €64 billion of the €255 billion they obtained in the two threeyear refinancing operations of December 2011 and February 2012. Improvement in the conditions on the wholesale funding market could facilitate early repayment of the remaining amounts. The tensions affecting credit supply stem above all from the increasing incidence of nonperforming loans in banks’ balance sheets and from their worsening perception of borrowers’ creditworthiness. New bad debts have ceased to rise in proportion to outstanding loans since the third quarter of 2013, and in our estimates should remain virtually stable in the coming quarters. However, reflecting the long recession, the ratio of total bad debts to total loans reached 9.1 per cent in December, almost 7 percentage points higher than at the end of 2008. For loans to firms, the ratio rose from 3 to 13 per cent. The requisite provisions for the deterioration in loan quality dent banks’ profitability; in the first nine months of 2013 they absorbed three quarters of operating profit. The return on equity was particularly low. In Italy, the private market in impaired assets is underdeveloped. Some recent transactions signal interest on the part of specialized investors in managing these assets. The actions under way at a number of banks to rationalize the management of non-performing loans by creating dedicated structures able to enhance the efficiency of the procedures and the transparency of these assets go in the right direction. More ambitious interventions, whose compatibility with European rules must be pondered, are not to be ruled out. They could, at moderate cost, release resources to be used for financing the economy. The revaluation of the Bank of Italy’s share capital has adjusted values that were unchanged for decades. The excess concentrations of holdings will be eliminated. The ensuing increase in the highest quality capital of the shareholding banks, though it cannot be considered in the assessment of asset quality being conducted in the euro area, will help to sustain the supply of credit. As the economic recovery gathers strength and the riskiness of loans gradually diminishes, the banking system will be able to offer greater support to the economy, helping in turn to stimulate growth. A contribution to this can come from targeted measures, some of them already decided, such as the refinancing of the Guarantee Fund for SMEs and changes to the tax rules on loan loss provisions in banks’ balance sheets. The Bank of Italy’s supervisory action and the banking union Thanks in part to the action of the Bank of Italy and in spite of the sharp deterioration in loan quality, between September 2012 and September 2013 the non-performing loan coverage ratio rose from 38.3 to 39.9 per cent on average for Italian banking groups. The ratio of core BIS central bankers’ speeches tier 1 capital to risk-weighted assets rose from 10.0 to 10.6 per cent. Coverage and capital ratios must continue to increase; this preserves investors’ confidence in the banks and lowers the cost of funding, thus helping to ensure an adequate flow of credit to economic activity. During the crisis, lending has been more buoyant at the better-capitalized banks. The Bank of Italy is scrutinizing the weaknesses in the structure and working of banks’ boards of directors; the aim is to remove factors that can hinder banks’ capital strengthening and to foster better business management. The proposals put forward in last December’s public consultation document are designed to improve banks’ governance by limiting the number of directors and increasing the possibility for shareholders to make their views known. The Bank will take account of the comments that emerged during the public consultation when it issues the final provisions. Correct organizational arrangements are essential for efficiency and stability. The growth in the number of banks in difficulty was mainly due to the recession, but weak governance systems also played a role, as did episodes of outright malfeasance. During the crisis the vicious spiral between the state of the banks and that of their respective sovereign issuers had a perverse effect on intermediaries’ creditworthiness and their ability to raise funds in the market. Banking Union can make a decisive contribution to breaking this link. The first step is the launch of the single supervisory mechanism. The comprehensive assessment of the leading euro-area banks’ balance sheets to be carried out by the ECB and the national authorities will contribute to the single supervisory mechanism’s launch, at the end of this year, on a solid and credible basis. This will make clear and comparable information available on the state of European banks’ health. The exercise will be carried out transparently and rigorously, with uncertainty about the way it is performed reduced to the minimum. The assessment will cover all the asset items and the related risk profiles. In examining the quality of exposures, uniform criteria will be used, in line with Italian practices, which are acknowledged to be among the most scrupulous. The first phase of the examination of the quality of banks’ assets, devoted to the selection of riskier portfolios, is drawing to a close. In the second phase, which will get under way in the coming weeks, a large number of credit files will be analyzed and the adequacy of the value adjustments in banks’ accounts will be assessed. In the last few days the European Banking Authority and the ECB have announced the main features of the stress test. The exercise will refer to the three years 2014–16. The threshold value of the capital ratio that banks must comply with at the end of the period is 8 per cent in the baseline scenario and 5.5 per cent in the adverse one. The definition of capital, which will take due account of the choices made by national authorities, in line with the provisions of the transitional regime, will be that in force at the end of 2016. The corrective measures that intermediaries will be asked to take will be related to the nature of the capital weaknesses revealed by the stress test. If they emerge in the baseline scenario, banks will be asked to implement the necessary measures rapidly; if, instead, they only appear in the adverse scenario, the time frame will be determined appropriately as part of a recapitalization plan agreed with the supervisory authorities. In recent months I have already drawn attention to the need for a rapid definition of public backstop mechanisms, capable of reassuring the markets about the authorities’ determination to tackle and overcome any weaknesses that should emerge from the assessment exercise. The design of the Banking Union must be completed with the introduction of the single resolution mechanism for failed banks. The negotiations under way between the Council, the Commission and the European Parliament on the agreement reached by the Council at the end of last year must move forward and be concluded rapidly, so as to allow the responsibilities of supervision to be aligned with those of the management and resolution of crises as soon as possible. The decision-making process must be speeded up and made more effective. The long transitional period envisaged before the resolution BIS central bankers’ speeches fund becomes fully effective must be shortened, so as to make the overall mechanism entirely credible. In order to return to rapid, sustained economic growth it is not enough to eliminate the factors of risk that I have recalled – to counter excessive disinflation, ensure the credibility of fiscal consolidation and stimulate renewed lending. Italy has still not risen properly to the challenges of technological innovation and the globalization of markets. Mere financial support to troubled sectors is no solution. Competitiveness can be recovered only through a wide- ranging, consistent reform strategy involving the public sector, firms and the financial system. The commitment to creating a more business-friendly institutional and legal environment has to be strengthened, with further simplification of rules and regulations, improvement in the quality of essential public services, and continuing action to combat illegal behaviour. Especially in today’s circumstances – marked by profound transformation – an easing of the fiscal burden on productive factors, together with selective spending cuts to reduce waste and measures to make government more efficient, can be decisive to the ability of the system to undertake the necessary changes. Income support, retraining and job placement programmes for workers driven out of traditional forms of production are needed to protect those who will be disadvantaged in the short term. There is no lack of firms capable of taking up the challenge, growing large enough to compete in global markets, increasing the technological and innovative content of their products. A better balance in sources of finance, reducing dependency on bank loans and increasing the importance of equity capital, would help in providing enterprises with adequate resources. New forms of intermediation can facilitate the financing of firms by institutional investors. In other countries, banks’ ability to stimulate and sustain innovation on the part of firms – including by offering high-value-added financial services – is one of the key drivers of economic growth. In Italy as elsewhere, the financial system must regain public trust, which has been sapped by the excesses, occurring mostly in other countries, that led to a global crisis with enormous costs. It must demonstrate its ability to perform its function to the full. The negative perceptions of the conduct of banking and finance must not be allowed to trigger disproportionate reactions. Public hostility must be overcome through decisive improvements to governance and through sound and prudent intermediation, ensuring that finance is not denied to those who deserve it and share the risk and that the financial system continues to support real economic activity. We are fully conscious of the difficulties that lie ahead. We are working to help remove them in the firm belief that sound finance remains essential to eliminate the liquidity constraints that cramp economic activity and prevent the fruitful exploitation of ideas and to promote growth by fostering innovation. BIS central bankers’ speeches | bank of italy | 2,014 | 2 |
Speech by Mr Fabio Panetta, Deputy Director General of the Bank of Italy, at The Adam Smith Society, "Italians' savings are in support of growth", Milan, 27 January 2014. | Fabio Panetta: A financial system for growth Speech by Mr Fabio Panetta, Deputy Director General of the Bank of Italy, at The Adam Smith Society, “Italians’ savings are in support of growth”, Milan, 27 January 2014. * * * This text has benefited from the comments and suggestions received from Piergiorgio Alessandri, Paolo Finaldi Russo, Giorgio Gobbi, Antonio De Socio and Luca Zucchelli. 1. Introduction The economic and social costs of the double-dip recession that hit Italy over a brief period of time are very great. GDP has fallen by 9 per cent since 2007, industrial output by 25 per cent. There are fewer job opportunities: the number of persons in employment has fallen by 1 million, the unemployment rate is nearly 13 per cent, and more than 41 per cent among young people. The inequality indices have worsened: in 2012 the richest 10 per cent of households held 46.7 per cent of the country’s wealth, up from 44.3 per cent in 2008. The consequences of the crisis mainly affect the young, whose prospects are dim compared with past generations. The crisis originated abroad, but its effects have been accentuated by the structural weaknesses of the Italian economy, the first of which are the high public debt and the delayed response of industry and the institutional structure to technological progress, globalization and the introduction of the euro. Italian banks successfully withstood the first wave of the crisis, which was financial in nature. However, the persistence of the recession and the sovereign debt crisis caused a worsening of the conditions for wholesale funding and credit quality, especially as regards business loans, which then undermined banks’ balance sheets. The increase in the amount of non-performing loans has been magnified by the financial fragility of firms. The low level of equity and the consequently high debt burden have squeezed business profitability, reducing resistance to external shocks. The pre-eminent role of credit compared with market financing has rendered firms vulnerable to a tightening of bank credit. These weaknesses were already present in the previous decade but have come to the fore during the recession. The crisis has revived the unresolved problems of the Italian financial system: the dependence on banks, the lack of developed equity and bond markets, the inability to provide the productive system with resources other than credit. During negative phases of the cycle, this situation limits lending to business and makes it more costly, entailing high risks for banks, financial stability and economic activity. But the crisis also provides incentives to strengthen the role of the capital market and make the structure of the financial system more balanced. In the following pages, I will analyse the salient points of these themes and possible ways of overcoming the financial constraints which are still weighing on the Italian economy. 2. Business credit and the financial crisis In 2000, following the start of monetary union, the ratio between banks’ business lending and GDP was at a similar level in the four leading euro-area countries, on the order of 35–40 per cent (Figure 1). Significant gaps emerged in the following years up to the global financial crisis: against a fall of 4 percentage points in Germany, the ratio increased by 5 points in France, 15 points in Italy and 46 points in Spain. BIS central bankers’ speeches In Italy, the growth of business lending was fostered both by strong demand and by favourable supply conditions. With the adoption of the euro, bank lending rates fell, eliminating the spreads relative to countries with a longer tradition of price stability. The availability of low-cost wholesale funding allowed banks to separate the growth of lending from that of retail funding. The share of loans not funded by retail deposits and retail bonds (the funding gap) rose from 10 per cent in the first few years of the century to 21 per cent in 2008. During the financial crisis, credit conditions worsened. Since the autumn of 2008 growth in bank lending to the private sector has gradually slowed, becoming negative for the first time in the course of 2009 and again from the end of 2011 to the present. 1 The contraction in the last two years has been marked as regards lending to business, which declined by €98 billion against a reduction of lending to the private sector of €114 billion (Figure 2). Besides the fall in demand connected with the recession, the contraction in lending reflects banks’ restrictive lending standards. 2 It is estimated that, in 2012, the more stringent lending criteria determined an 8 per cent contraction in the stock of loans and an increase of 2 percentage points in lending rates. 3 The credit strains had negative repercussions on investment and therefore on growth; 4 hardest hit were small firms and new business initiatives: in the first three months of 2013 the balance of business start-ups and closures (7,700 firms) was eight times lower than in the three-year period before the crisis. With tensions on the funding side resolved following intervention by the Eurosystem, supply constraints reflect, above all, the deterioration in the creditworthiness of non-financial firms. Loans to firms with repayment difficulties (“non-performing loans”) account for almost a quarter of all credit to the sector, increased by 10 percentage points in only two years; within this aggregate, the component with the highest probability of loss for the banks (“bad debts”) accounts for 12 per cent of loans (Figure 3). Credit losses absorb a large part of banks’ operating profits. The scarcity of credit is set to continue in the months to come. Empirical evidence indicates that the deterioration in loan quality tends to extend well beyond the start of a cyclical recovery. 5 Moreover, banks are reducing the size of their balance sheets in response to factors of a structural nature, such as market pressure to reduce leverage and the tightening of the capital and liquidity requirements under international regulations (Basel III). In the euro area, the banks’ caution is also fueled by the transition to the Single Supervisory Mechanism. Once the mechanism is operational, it will help to dissipate fears about banks’ soundness and eliminate the financial and regulatory segmentations and constraints that now weigh on the European credit market. In particular, the comprehensive assessment of banks’ balance sheets by the ECB and national supervisory authorities will increase the information available and strengthen banks’ capitalization. There was a 5.6 per cent annualized contraction in credit in the three months ending in November 2013. Credit supply tensions during the crisis are documented both in empirical studies and by surveys of banks and businesses. See F. Panetta and F. M. Signoretti, “Credit demand and supply in Italy during the financial crisis”, Occasional Papers, No. 63, Bank of Italy, April 2010; P. Del Giovane, A. Nobili and F. M. Signoretti, “Supply tightening or a lack of demand? An analysis of credit developments during the Lehman Brothers and the sovereign debt crises”, Working Papers, No. 942, Bank of Italy, November 2013. See Del Giovane, Nobili and Signoretti, ibid., See E. Gaiotti, “Credit Availability and Investment: Lessons from the Great Recession”, European Economic Review, Vol. 59, April 2013; F. Busetti e P. Cova, “The macroeconomic impact of the sovereign debt crisis: a counterfactual analysis for the Italian economy”, Occasional Papers, No. 201, Bank of Italy, September 2013. See M. Bofondi and T. Ropele, “Macroeconomic determinants of bad loans: evidence from Italian banks”, Occasional Papers, No. 89, Bank of Italy, March 2011. BIS central bankers’ speeches The exercise will be conducted with uniform rigorous standards in all the member states; all the main sources of risk will be evaluated, avoiding excesses that instead of reassuring the markets would only reinforce the spiral between sovereign debt and bank risk. The path to the Single Supervisory Mechanism is not without risks, however. In the short run, uncertainties about how the comprehensive assessment is to be conducted could heighten banks’ caution, thereby compressing credit supply. A transparent policy of communication can mitigate these uncertainties but cannot eliminate them entirely, since the enormous complexity of the exercise makes it impossible to shorten the time needed to complete the comprehensive assessment. During the construction of Banking Union, moreover, its incomplete structure might not be sufficient to protect the economy and the public finances from the consequences of banking crises. 3. Firms’ financial fragility A reflection is necessary on the origin of the constraints on lending to businesses and on how they may be overcome. Analysis must focus in particular on the factors that together with the recession increase credit risk which, as we have seen, is a powerful obstacle to the supply of loans. The recent financial tensions have generally been viewed in relation to the problems of the banks, which in turn are connected to the recession and the sovereign debt crisis. While such an approach was comprehensible at the height of the crisis, it overlooks the problems deriving from firms’ financial fragility. The rapid expansion of bank lending between 2000 and 2008 had its counterpart in that of the debt of non-financial corporations (Figure 4), which rose as a proportion of value added by more than 50 percentage points, to 178 per cent. The growth in corporate debt was not paralleled by a strengthening of firms’ ability to support its cost: productivity stagnated, profitability worsened (Figure 5); the portion of investment covered by self-financing fell to the historic low of 38 per cent. Above all, firms’ equity did not keep pace with their indebtedness: their leverage ratio 6 rose from 34 to 43 per cent, and this helped drive up their net interest expense in relation to gross profits. Italian firms’ leverage is also relatively high by international standards (Figure 6). According to the financial accounts, in 2012 it exceeded the euro-area average and the figure for Germany by 6 percentage points and was 14 points higher than in France. Comparable gaps existed in the years before the crisis. The results do not change when firm-level data are used. 7 Based on a sample of 600,000 euro-area companies, in 2010 Italian firms’ leverage was higher than the others’ in nearly every sector and size class (Figures 7 and 8). 8 These differences do not reflect composition effects. According to econometric analyses that take account of the main firm characteristics bearing on indebtedness, 9 Italian firms’ leverage is 11 percentage points higher than the average for the other countries. The gap is wider for smaller companies, while it is virtually nil for very large companies (assets of more than €300 million). Financial debts in relation to the sum of shareholders’ equity and financial debts. The financial accounts do not allow us to tell if the differences between countries reflect the composition of the productive economy by sector and firm size. In addition, they include shareholders’ equity at market prices, which makes international comparisons depend on the performances of the stock markets. The data are from the Amadeus database, which includes financial statement information for companies of 46 countries. Leverage was analyzed by means of panel regressions, including a dummy for Italian firms among the independent variables. The control variables included dummies for sectors, size classes and age groups, as well as financial statement variables (profitability, technical fixed assets, liquidity and sales growth). BIS central bankers’ speeches 4. Towards a more diversified financial system A continuation of the present financial tensions would entail high risks for the Italian economy. The exit from a recession is slower in the presence of a financial crisis or a credit squeeze; in such situations, lending normally begins to revive half a year after GDP. 10 In Italy, as elsewhere, lending to businesses has lagged the real economy and been influenced by the presence of restrictions on credit supply (Figure 9). In order to ensure the full functionality of the financial system and provide adequate resources to Italian firms in view of the cyclical upturn, both short-term and structural measures are needed. The tensions in the credit market and the financial fragility of firms reflect contingent factors – the recession and the sovereign debt crisis – but are closely bound up with the weaknesses of the Italian financial system: the over-reliance of firms on bank credit and insufficient direct fund-raising on the markets. A financial set-up of this kind is especially penalizing in the present conjuncture. The negative effects on credit supply of the high risk of default must be counteracted. Looking further ahead, it is necessary to foster the development of a diversified financial system in Italy in which the role of the capital markets and institutional investors is on a par with that in the other main countries. These issues are addressed in the following pages. 4.1 Bank credit The instruments best suited to tackling the “market failure” at the root of the current malfunctioning of the credit market 11 are based on systems that guarantee bank loans to firms, and to smaller firms in particular. 12 Since the onset of the recession the Guarantee Fund for small and medium-sized enterprises has been appropriately reinforced, through an increase in its endowment, the widening of the range of potential beneficiaries, and the broadening of the eligibility criteria. A government backstop guarantee was introduced, relieving banks from capital charges for loans covered by the Fund. Thanks to the leverage effect and to diversification, the interventions weigh only moderately on the public finances. In recent years the flow of loans guaranteed by the Fund has risen rapidly. Between 2009 and 2012 guaranteed loans amounted to €31 billion, assigned to 127,000 mostly small firms. At the end of 2012 the stock of such loans accounted for 3.5 per cent of loans to firms with less than 20 workers in the sectors where the Fund operates. In the first ten months of 2013 guaranteed loans amounted to €8.5 billion (Figure 10), up by 23 per cent from the same period in 2012. According to preliminary analyses conducted by the Bank of Italy, the guarantee provided by the Fund supported the growth in bank lending to the beneficiary firms. 13 The effects on the cost of lending appeared instead less clear-cut; this may be attributable in part to how the Fund operated in the past, when it allowed banks to obtain a guarantee after the loan had been disbursed, and therefore after its terms had been defined. See C.M. Reinhart and K.S. Rogoff, This Time is Different: Eight Centuries of Financial Folly, Princeton University Press, 2009; S. Claessens, M.A. Kose and M.E. Terrones, “What happens during recessions, crunches and busts?”, Economic Policy, Vol. 24, 2009; A. Abiad, G. Dell’Ariccia and B. Li, “Creditless Recoveries”, IMF Working Paper 11/58, 2011. The current situation in credit markets is well documented in economic analysis, whereby the high risk of default and the difficulty of assessing the solidity of borrowers leads to adverse selection and increases intermediaries’ risk aversion, giving rise to credit rationing. See J. Stiglitz, and A. Weiss, “Credit Rationing in Markets with Imperfect Information” (1981), The American Economic Review. OECD, Financing SMEs and Entrepreneurs: An OECD Scoreboard, OECD Publishing (2013). Conducted on a sample of manufacturing firms that benefited from the Fund’s intervention between 2005 and 2010. BIS central bankers’ speeches Over the coming months the Fund’s activities may benefit from the changes introduced under Law 98/2013 and the 2014 Stability Law. However, these must be implemented rapidly: some of the changes, in particular those designed to facilitate the granting of guarantees to firms whose balance sheets have been weakened by the recession, are still awaiting implementing decrees. Moreover, the prospect that a portion of the funds assigned by the Stability Law could be channelled to other areas of activity and for purposes other than supporting firms, risks dissipating the Fund’s resources and eroding its effectiveness. Finally, to stimulate the supply of loans there is a need to introduce mechanisms that reward banks with the highest rates of increase in total lending. Further interventions to support credit have been made by the public sector through the Cassa Depositi e Prestiti. 14 In the private sector, the moratoriums agreed between the Italian Banking Association and firms’ associations have enabled many SMEs to weather difficult times. But to get the credit channel working again, banks must first and foremost commit to taking full account of their customers’ growth potential. The pressure on banks to deleverage and, in the years leading up to the crisis, the growing importance of types of financing that can be sold on the market may have impaired the ability and incentives for banks to analyze the prospects of the various business sectors and carefully assess borrowers’ creditworthiness. This negative trend must be halted, by intensifying efforts to examine the characteristics of firms, and of smaller firms in particular. Banks must be aware of the negative effects for the entire Italian economy, and for themselves, of an indiscriminate credit crunch. 4.2 Equity capital In addition to credit, Italian firms require equity capital, in order to support the economic recovery and ensure more stable financial conditions. It is estimated that in order to bring the leverage of Italian non-financial companies in line with the European average would require the conversion into equity of debt totaling between €150 and €220 billion. 15 Such an operation would be considerable in scope but feasible over the medium term: if completed within five years it would require the transformation into equity every year of debts corresponding to 3 per cent of the total; it would be less arduous during a period of economic growth, above all if accompanied by the reinvestment in firms of a large portion of the earnings distributed every year to shareholders in the form of dividends (€60 billion on average in 2011–12, based on Istat data). The rebalancing of the sources of financing requires interventions on several fronts. First, incentives for incurring debt must be eliminated. Of these, high taxation plays a nonnegligible role, both directly and indirectly. Heavy taxation of firms’ earnings increases the advantages of borrowing with respect to other forms of financing, owing to the deductibility of interest payments from annual earnings. Italy’s high tax rates enable firms to deduct a larger proportion of financial costs from taxable income than is possible elsewhere. It is estimated that this explains much – about one fourth – of Italy’s unfavourable leverage gap with respect to other European countries. 16 Since the onset of the crisis the CDP has constituted funds on which banks can draw at a low cost in order to provide medium and long-term credit to SMEs. The SME credit line, set up in 2009 with an endowment of €8 billion, has been fully exhausted; the “new SME credit line”, operational since 2012, has an endowment of €10 billion, most of which has not yet been disbursed to firms. This estimate is based on the data discussed in Section 3, which maintains unchanged the total value of firms’ financial liabilities (i.e. only modifying the debt-to-capital ratio). A. De Socio and V. Nigro, “Does corporate taxation affect cross-country firm leverage?”, Bank of Italy, Working Papers No. 889 (2012). BIS central bankers’ speeches High taxation also increases firms’ reluctance to tap the markets. In Italy the underdevelopment of the stock exchange does not stem from a lack of listable companies. 17 It mainly reflects the choices of firms themselves: 18 Italian firms, characterized by a high degree of concentration of equity in the hands of a few people, often linked by family ties, are reluctant to open up. Increasing firms’ size and turning to the markets imply costs associated with greater exposure to supervisory authorities, minority shareholders, and above all the taxman, given the excessively burdensome level of taxation. One reason for the lack of interest in stock exchange listing is the strong desire to retain control of the firm, sometimes even at the cost of doing without the financial and management resources needed to stay ahead of international competition. This goes against what empirical analyses tell us. After a firm has been admitted to the stock exchange, its financial structure becomes sounder, with a bigger share of bond issues and a smaller share of short-term loans. Listing also allows the firm to cut the cost of bank loans by improving its risk profile and its reputation. 19 Signs of renewed interest in the stock exchange have emerged in recent months. Some twenty Italian companies have gone public since January last year, the largest number since 2007; others have announced similar plans. Most of these firms are small and medium-sized non-financial companies that decided to list on the alternative investment market (AIM) where listing costs and regulatory requirements are lower than on the main stock exchange. Tax incentives for company listing or equity finance have been used on several occasions in the past to promote the growth of the stock exchange. 20 The measures had limited success because of the temporary nature of the tax benefits, which meant they could not fully offset the firm’s perceived cost of listing, including the cost of transparency. The tax allowance for corporate equity introduced in 2011 as part of the package of measures to aid economic growth reduces the tax advantage of debt relative to equity capital and will hopefully go some way to overcoming the above-mentioned limits. However, our research indicates that so far the effects have been limited: fewer than 2 per cent of firms report they increased their shareholders’ equity in 2012–13 to take advantage of the allowance. This result may be due not only to the lack of profits available to reinvest in the firm, but also to the small size of the incentives, which need to be sufficiently large and permanent in the eyes of the firm if they are to be effective. 21 See the Technical Planning Document drawn up by the Working Group for the admission to listing of SMEs (March 2013). Based on a comparison with France, where the productive system differs from the Italian one, it is estimated that as many as 500 Italian companies are eligible for listing. See F. Panetta, “Banks, Finance, Growth”, speech delivered at the conference “Beyond the crisis: What lies in store for Italian banks?”, organized by the Associazione per lo Sviluppo degli Studi di Banca e Borsa in conjunction with the Università Cattolica del Sacro Cuore of Milan (2013). See also Pagano, Panetta and Zingales, “Why Do Companies Go Public?”, Journal of Finance (1998). See Pagano, Panetta and Zingales, ibid. Incentives were granted for equity finance and company listing under the Visentini Law (1983), the Tremonti Law (1994), the Dual Income Tax measure (1997) and the Tecno-Tremonti Law (2003). The advantage of borrowing in terms of taxation can be eliminated quite simply by bringing the notional rate of the tax allowance for corporate equity into line with the long-term risk-free interest rate. See R. Broadway and N. Bruce, “A General Proposition on the Design of A Neutral Business Tax”, Journal of Public Economics, 1984, and R. De Mooij, “Tax Biases to Debt Finance: Assessing the Problem, Finding Solutions”, Fiscal Studies, 2011. BIS central bankers’ speeches The larger tax allowance introduced under the Stability Law for 2014–16 is a step in the right direction. Other incentives covering a longer time frame could be offered to newly listed firms without encroaching too much on government revenue. 22 4.3 Non-bank financing During the financial crisis Italian firms turned increasingly to the bond market. Placements have averaged €30 billion a year since 2009, with peaks of over €35 billion in 2009 and 2012, when it was hardest to access bank credit (Figure 11). Issuance was substantial in 2013 as well, amounting to €29 in the first nine months. While bond issuance continues to lag behind the levels of other advanced countries and its costs remain relatively high, the upturn is a clear step forward with respect to the pre-crisis period (bond issues averaged €19 billion a year in 2005–07). Thanks to their bond placements firms have become less dependent on bank lending: out of the 250 main Italian industrial groups, the 80 that made bond issues in 2009 also reduced their bank borrowing by a third, while the others increased it by 12 per cent. The progress in overall bond issuance masks differences between the various size groups of firms, however. In fact the increase in placements concerns only a small number of large firms, while the value and volume of placements by small and medium-sized firms has declined (Figure 12). 23 The number of small firms going to the bond market for the first time has progressively diminished and the number of medium-to-large firms has remained stationary. Last year, issuance by unlisted companies was encouraged by the tax benefits offered under the economic growth decree of June 2012 which created so-called minibonds. Twenty or so of these issues were placed for a total value of about €5 billion. Once again, small firms took little advantage of the opportunity. The difference between placements by large and small firms mirrors the difficulty SMEs have in placing small-value, and hence illiquid, bond issues and in approaching major investors, particularly from abroad. A further problem is the difficulty of assessing the creditworthiness of small firms, particularly during the current recession. These factors lead to placements of illiquid, high-yield securities. 24 The problems SMEs encounter in accessing the bond market opens up a range of opportunities for specialized intermediaries able to assess the credit rating of small firms and practice investment strategies designed to diversify idiosyncratic risk over the medium-tolong term. Several projects are under way to create instruments for investing in bonds or loans of unlisted companies, most of them based on the creation of closed-end credit funds. This may help to channel funds rapidly to issuers and create a market that could, as it reaches a suitable size and becomes sufficiently liquid, attract even major institutional investors. The success of such projects depends on a high degree of transparency, simple structures, low leverage, and limited maturity mismatching. See A. Franzosi and E. Pellizzoni, “Gli effetti della quotazione. Evidenza dalle mid & small caps italiane”, BIt Notes, 2005; G. Giudici and S. Paleari, “Should Firms Going Public Enjoy Tax Benefits?”, European Financial Management, 2003; M. Geranio and E. Garcia, Come sarebbe l’Italia con 1.000 società quotate?, 2012, mimeo, Bocconi. The data in the text are obtained by combining the public information provided by Dealogic Ltd. with information from the Bank of Italy’s register of securities. The latter source also includes small value bond issues. The average yield on the five smallest value issues is about 7.5 per cent. BIS central bankers’ speeches Credit funds can make a far from negligible contribution to diversifying firms’ funding sources, particularly the medium-to-long-term component. 4.4 Securitizations The transformation of Italy’s “bank-centred” financial system to one in which firms, including smaller firms, can directly tap market financing is an ambitious objective, attainable over a lengthy time horizon. It may require significant legal and fiscal adjustments. It presupposes changes in the behaviour of banks and firms. In the transition between these two models of corporate finance, consideration should be given to the possibility of exploiting synergies from combining intermediaries’ activities with those of the markets. One such possibility is offered by securitizations, which allow the separation of the typical banking functions – screening borrowers and originating loans, which continue to be performed by the bank – from financing proper, which is shifted to the market. In practical terms, the securities generated constitute the synthetic replica of a bond portfolio, but with the significant difference that the task of debtor selection and screening is left to the bank, not to the final investor, as in the case of corporate bonds. The senior tranche of an assetbacked security, unlike the underlying loan, can be sufficiently transparent and liquid to be placed with unsophisticated investors. Securitizations accordingly enable firms to reach institutional investors without bearing the costs of stock exchange listing or bond issues. They enable purchasers to delegate the task of procuring information to banks, which are in a better position to perform it. In addition, securitizations can alleviate the problem of mismatching of demand and supply that can arise in illiquid markets when companies have trouble issuing securities because “there’s no demand” while demand itself is slack because the scarcity of outstanding securities means that for investors “it’s hard to diversify”. With the crisis, the securitization market has practically dried up. I won’t go into the reasons for this collapse – the potential risks of a perverse intermingling of intermediaries, markets and securitizations are known well enough. But Italy’s experience in recent years shows that attentive banking supervision makes it possible to combine the two functions in virtuous fashion, providing the right incentives to banks and mitigating information asymmetry. 25 In the decade preceding the crisis, in a favourable economic environment, Italian banks reduced the impaired loan assets in their portfolio, among other things through substantial securitizations. In coming months the volume of such operations may be fueled by several factors: the cyclical recovery will improve borrowers’ creditworthiness, bolstering specialized intermediaries’ demand for impaired assets; an analogous effect will continue to come from the concomitant reduction of “Italy risk”, as evidenced by the narrowing of the spreads on government bonds. The supply of impaired loan assets by banks should also grow, owing to the increase in value readjustments and the recent regulatory changes bringing less unfavourable tax treatment of write-downs and loan losses. The resumption of securitizations will interact positively with the need to diminish the stock of impaired loans in order to free up resources to finance economic activity. 26 5. Conclusion The Italian economy, after protracted recession, is heading towards a cyclical upturn. The signs of improvement that emerged last spring are strengthening. Last summer the decline in GDP came to a halt, and in the fourth quarter industrial production apparently gained around U. Albertazzi, G. Eramo, L. Gambacorta and C. Salleo, “Securitization is not that evil after all”, Bank of Italy Working Papers No. 796, February 2011. Bank of Italy, Financial Stability Report No. 6, November 2013. BIS central bankers’ speeches one per cent. The quarterly change in GDP appears to have been positive for the first time since mid-2011. Italy’s financial markets are benefiting from the decreasing financial fragmentation of the euro area. The revival of foreign investors’ appetite for Italian assets has been reflected in a reduction in the Bank of Italy’s debtor position with the TARGET2 payment system, which has diminished by a third from the high mark of €290 billion registered during the summer of 2012. The economic picture nevertheless remains fragile. International financial tensions are again threatening global market stability. The Italian economy is improving only slowly, with considerable unevenness both geographically and by sector. To maintain the recent positive signs and convert them into sustained, robust economic growth that can cut significantly into Italy’s high unemployment will require the country to finally tackle and begin solving a series of well-known structural problems on which action has been deferred for too long. Another necessity is adequate financial support for firms. There can be no return to growth without the contribution of banks and markets. Past efforts to foster the development of a more diversified financial system – one in which the importance of markets and institutional investors is comparable to the other leading countries – have not yielded the hoped-for results. The recession, the increase in credit risk and the resulting credit supply strains have nevertheless created incentives for firms and banks to renew those efforts, to make them more effective and to expand direct finance to the productive economy. In recent months Italian firms have shown a greater propensity to turn to the capital market. Both bond issues and new stock exchange listings have increased. But market recourse remains modest and for the most part limited to larger companies. Small businesses have not taken proper advantage of the opportunities for direct financing. Banks can be essential in encouraging direct access to the markets for larger firms and pointing smaller ones in the same direction. If they accompany firms with good growth prospects into the market, developing corporate finance services that take less capital and liquidity, they can curb risks and improve earnings. To attain these objectives they need to strengthen relationships with firms and avoid conflicts of interest. Firms too must contribute to the development of the capital market. Corporate financing needs cannot be met by bank credit alone. Diversifying funding sources will require a commitment to greater accounting transparency, openness to outside parties, and above all capital strengthening. In order to gain the support of banks and investors, entrepreneurs will have to be the first to demonstrate their own faith in the prospects for their business. The task of economic policy is to remove the obstacles, to provide incentives to ensure that the development of the capital market gathers momentum and, above all, that it does not flag as in the past. Like the rest of the Italian economy, this process would benefit from an easing of the tax burden on firms. BIS central bankers’ speeches Figure 1 Bank loans to firms in the main euro-area countries (as a percentage of GDP) 90.0 France Germany 80.0 Italy Spain 70.0 60.0 50.0 40.0 30.0 20.0 Sources: ECB and Eurostat. Figure 2 Bank loans in Italy (stocks in billions of euros) 1,600 1,500 1,400 Private sector of which: non-financial corporations 1,300 1,200 1,100 1,000 Source: Bank of Italy. (1) Data not adjusted for seasonal factors or securitizations. BIS central bankers’ speeches Figure 3 Non-performing loans to firms (as a percentage of loans to firms) 25.0 20.0 15.0 10.0 Bad debts Substandard loans Restructured loans Sep-13 Jun-13 Mar-13 Dec-12 Sep-12 Jun-12 Mar-12 Dec-11 Sep-11 Jun-11 Mar-11 Dec-10 Sep-10 Jun-10 Mar-10 Dec-09 Sep-09 Jun-09 Dec-08 - Mar-09 5.0 Past due Source: Bank of Italy. Figure 4 Firms’ financial debt (per cent) 120.0 5.0 110.0 0.0 100.0 Leverage 2013 10.0 130.0 15.0 140.0 20.0 150.0 25.0 160.0 30.0 170.0 35.0 180.0 40.0 190.0 45.0 200.0 50.0 Financial debt / value added (RH scale) Sources: Bank of Italy and Istat. (1) With reference to June 2013. BIS central bankers’ speeches Figure 5 Firms’ profitability (per cent) MOL / Valore aggiunto (sc. sx) Oneri finanziari netti / MOL (sc. sx) MOL/Attivo (sc. dx) Sources: Bank of Italy, Istat and Cerved Group. (1) Provisional data for 2012; the broken line refers to a sample of firms with balance sheets for both years. Figure 6 Firms’ leverage in Italy and the other leading countries (per cent) Italy France Germany Spain United Kingdom United States Sources: ECB, Bank of England and Federal Reserve System. BIS central bankers’ speeches Figure 7 Leverage by size class (weighted averages; 2010; only indebted firms) 60.0 IT GE FR SP Total 17 50.0 40.0 30.0 20.0 10.0 0.0 Total Micro Small Large Medium-sized Source: Amadeus. Figure 8 Leverage by sector of economic activity (weighted averages; 2010; only indebted firms) GE FR SP Total 17 Energy IT 60.0 Manufacturing 70.0 50.0 40.0 30.0 20.0 Retail trade ICT Construction Wholesale trade Lodging&catering Transport&communic 0.0 Other services 10.0 Source: Amadeus. BIS central bankers’ speeches Figure 9 Correlation between GDP and lending to non-financial corporations (in real terms; different leads/lags) 1.0 0.8 0.6 0.4 0.2 0.0 -0.2 -0.4 -0.6 Correlations between 12-month rates of change: GDP (t), lending to non-financial corporations (t±k) - Period: 1995-2013 -0.8 Correlations between levels, controlling for the supply of credit: GDP (t), lending to nonfinancial corporations (t±k) - Period: 2002-2013 -1.0 -8 -7 -6 -5 -4 -3 -2 -1 Sources: Bank of Italy and Istat. (1) The correlations that take account of the supply of credit are based on the residuals of regressions of the time series of GDP and of lending to firms on the indicator of the supply of credit drawn from the Bank Lending Survey. Figure 10 Loans guaranteed by the Guarantee Fund for SMEs (annual flows in billions of euros) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Management Committee of the Guarantee Fund for SMEs. (1) With reference to the period January–October. BIS central bankers’ speeches Figure 11 Gross bond issues by Italian non-financial corporations (millions of euros and numbers) 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 - Number of issues (RH scale) Number of issuers (RH scale) Gross issues (LH scale) Sources: Bank of Italy and Dealogic. (1) With reference to the period January–September. Figure 12 Gross bond issues by firm size (millions of euros and numbers) (a) Large firms (b) SMEs 40,000 35,000 30,000 25,000 - - Number of issues (RH scale) Number of issuers (RH scale) Gross issues (LH scale) 2013 Number of issues (RH scale) Number of issuers (RH scale) Gross issues (LH scale) 2013 5,000 10,000 15,000 20,000 Sources: Bank of Italy and Dealogic. (1) With reference to the period January–September. BIS central bankers’ speeches | bank of italy | 2,014 | 3 |
Lectio magistralis by Mr Ignazio Visco, Governor of the Bank of Italy, at the Almo Collegio Borromeo, Pavia, 25 March 2014. | Ignazio Visco: The exit from the sovereign debt crisis: national policies, European reforms and monetary policy Lectio magistralis by Mr Ignazio Visco, Governor of the Bank of Italy, at the Almo Collegio Borromeo, Pavia, 25 March 2014. * * * The road to European integration is a long and arduous one; it is not linear: we often advance step by tiny step, but at times by vigorous leaps. The introduction of the euro was one such leap; it was a definite advance but it certainly did not complete the journey. The euro is a currency without a State; this is the lack it suffers from. The divergences, sometimes the diffidence, that still mark the relations between the member states weaken the Economic and Monetary Union in the eyes of the international community and in those of its citizens. This incompleteness, together with the weaknesses of some member countries, has fueled the sovereign debt crisis of the euro area. If the weaknesses have engendered doubts about the sustainability of national public debts, the incompleteness has raised fears for the integrity of the union, allowed the risk of redenomination of the area’s financial assets and liabilities in national currencies to gather strength, and reintroduced exchange rate risk within a monetary union, thus further weakening the position of the countries in difficulty. Without political union, European economic governance has been founded upon budget rules and the ban on rescues between member countries; it has relied on the pressure of the single market for economic convergence. However, in many cases the budget rules have not been respected and the macroeconomic conditions have remained divergent, also structurally. The convergence of interest rates towards the low levels of the most “virtuous” countries allowed other countries to put off the necessary adjustments. For years the financial markets did not consider the possibility of an increase in sovereign risks. Before the crisis, the spreads between the yields on euro-area government securities had fallen to virtually nil. The tensions in the euro area came to a head in an environment already fragile as a result of the global financial crisis and the consequent recession of 2008–09. Initially they involved Greece in view of the state of its public finances, Ireland owing to its real-estate bubble and consequent banking crisis, and Portugal as a result of its macroeconomic imbalances. In the summer of 2011 the announcement of the involvement of private-sector investors in the restructuring of the Greek public debt clearly revealed the implications of the ban on the financial rescue of a Member State imposed by the Maastricht Treaty and of the lack of a protocol for handling sovereign crises. The tensions became systemic; the countries that suffered the most were Spain, above all owing to its banking system’s excessive exposure to the property market, and Italy, which was vulnerable because of its high public debt and the loss of competitiveness and growth capability in connection with the country’s pronounced slowness to adjust to the major political, commercial, demographic and technological changes of the last twenty years. The yield spreads between the euro-area’s sovereign securities increased rapidly. For some countries, including Italy, they rose far above the level justified by the economic fundamentals. The spread between ten-year BTPs and German Bunds, still less than 200 basis points in the first half of 2011, reached 550 basis points at the end of that year. After narrowing in the early months of 2012, it returned above 500 basis points in July. We estimated then − and explained in technical analyses and public interventions − that less than half of this amount was due to the weaknesses of our economy; the rest reflected the fears of the single currency breaking up. BIS central bankers’ speeches National policies and European reforms To achieve a given number of objectives, economic policy must have at least an equal number of independent instruments at its disposal. And in fact the European strategy in response to the crisis did identify two instruments with which to pursue two objectives: national policies to remove the fragilities present in individual economies and a strengthening of the union to dispel the fears for the integrity of the single currency. In this case, however, since the fears of euro reversibility and those for member countries’ debt sustainability fueled each other, the instruments were not independent. The reform of European governance thus necessarily hinged on the tightening of the budget rules and the introduction of new procedures for the control of other macroeconomic imbalances. The considerable time needed to implement this strategy conflicted, however, with the persistent market uncertainties and the lack of an instrument, such as a common budget, that would make it possible to combat the recession that had followed the financial crisis, offsetting the adverse short-term effects of the necessary national budgetary adjustments with expansionary unitary policies. The succession of conventional and unconventional monetary policy measures helped to make market conditions easier and, as far as possible, to counter the fall in demand. At the same time, in the worst-hit countries the aggravation of the social and economic consequences of the crisis made it harder to implement the necessary structural reforms, which, if they help to restore an economy’s growth potential, carry undeniable short-term costs. The immediate visibility of the results of budgetary policies has been obscured. In Italy, despite the reduction in the budget deficit from 5.5 to 3 per cent of GDP, between 2009 and 2013 the ratio of the public debt to GDP rose by more than 16 percentage points to 132.6 per cent, reflecting above all the brusque slowdown of the economy. One contributory factor, counting for nearly 4 percentage points, was Italy’s direct and indirect support to the financial adjustment of other euro-area countries. The fragmentation of the financial markets produced by the inception of a vicious circle between the situation of sovereign borrowers and that of the corresponding banking systems interfered with the transmission of monetary policy, making the conditions of financing to the economy severely dishomogeneous among the euro-area countries and holding back the expansionary impulses in the economies that most needed them. The gap between the cost of new loans to firms in Italy and Germany widened progressively from virtually nil in the summer of 2011 to one percentage point at the end of that year. With the three-year refinancing operations decided in December 2011 the Governing Council of the ECB countered the consequences of the fragmentation and prevented a much worse contraction in credit than actually occurred. In emergency conditions and with a good deal of uncertainty, national and European policies have nonetheless moved in the right direction overall. The state of the public finances of the countries most exposed to the crisis has improved, albeit at very high social costs in some countries. Reforms to support competiveness have been enacted and are being implemented. Above all, work has begun to rebuild trust among member states. At the outset of the crisis Europe had no instruments for financial assistance to sovereign issuers: the first measures in favour of Greece, and to a lesser extent Ireland, took the form of bilateral loans. With the European Financial Stability Facility (EFSF), a temporary arrangement set up in May 2010, and the European Stability Mechanism (ESM), a permanent institution with its own capital endowment inaugurated in October 2012, Europe secured a lending capacity of almost €700 billion. Between 2010 and 2013 over €320 billion in loans was disbursed to the countries in difficulty. Including the amount paid in towards the capital stock of the ESM, Italy’s contribution to this effort was in excess of €55 billion. The need to address the asymmetry between the single monetary policy and the multiplicity of national fiscal and structural polices has been recognized. The plan published by the European Commission in November 2012 and the report of the President of the European BIS central bankers’ speeches Council in June of the same year (updated the following December), plotted the stages of a further gradual strengthening of the Economic and Monetary Union. The first, Banking Union, is currently being implemented. Other, more difficult stages lie ahead: independent financial capacity for the euro area as a whole, a common budget and, in the future, political union. In advancing resolutely along this road, one important challenge remains: namely, a marked attenuation of the diffidence found today between governments and between national communities. To this end, Europe cannot confine itself to identifying the weaknesses of some, objective though they may be, and requiring adjustments, albeit necessary, with reference above all to the short-term results. We must look responsibly to the longer-term prospects, while also taking account of the sustainability of the sacrifices and the distribution of the benefits. Preparations for the Single Supervisory Mechanism (SSM), composed of the ECB and the national authorities, are proceeding apace. This constitutes a complex feat of institutional engineering, at least as demanding as that preceding the introduction of the single currency. Building on the accumulated technical expertise of the national authorities, the SSM must represent a supranational vision based on best practices in supervisory methods, analytical models and banking risk assessment. The transition to the single supervisor will enable easier comparison of the intermediaries and systems of the various countries, helping to combat the tendency to segmentation of financial markets along national lines. The comprehensive assessment of the euro area’s leading banks, currently being carried out in preparation for the launch of the SSM, goes in the same direction. The recent agreement of the European Council, Commission and Parliament on the Single Resolution Mechanism (SRM), due to be approved by the latter in plenary session in April, marks a further step towards Banking Union, with the harmonization of the responsibilities for crisis resolution, following that of supervision. With respect to the agreement previously reached by the European Council, this has simplified the decision-making process and shortened the time it will take for the mechanism to become fully operational. The SRM will operate through a Single Bank Resolution Fund financed out of contributions from the participating banks and managed by a Board comprising permanent members, representatives of the national resolution authorities, the ECB and the European Commission, the latter with observer status. The Board, on the basis of the ECB’s assessments concerning the existence of troubled banks, will determine whether bankruptcy can be avoided and whether there is a public interest justifying the activation of the resolution instruments. If so, it will draw up a crisis resolution plan subject to the approval of the Commission and, through a tacit consent procedure, of the Council. Disbursements of up to €5 billion will be decided at an executive session of the Board, comprising the permanent members and the resolution authorities of the countries in which the intermediary operates; other decisions will be adopted in plenary session, at which all the national resolution authorities participate. The Fund will reach its full endowment of €55 billion in eight years. The banks’ contributions will be paid into national compartments, which will be progressively mutualized starting with a share of 40 per cent in the first year and a further 20 per cent in the second. The Fund may also borrow on the market on the basis of decisions made in plenary session. All the operational aspects must now be rapidly finalized to permit accurate assessment of its financial capacity and to prevent uncertainty from amplifying the national component of risk premiums, thereby perpetuating financial market fragmentation and the vicious circle between the conditions of sovereign borrowers and banks. Outright monetary transactions As I observed, national policies and European reforms have introduced changes that will take a long time to implement; the distortions remaining in the financial markets in the meantime can jeopardize the whole process. During the crisis, the ECB’s Governing Council BIS central bankers’ speeches made decisive use of the instruments at its disposal, cutting official interest rates repeatedly and introducing new refinancing operations with a long maturity and full allotment. In August 2012 it announced Outright Monetary Transactions (OMT), a new way of intervening in the secondary market for government securities. The OMTs enabled the ECB to counter the effects of incorrect assessment of a sovereign borrower’s risk – in particular for the component linked to fears of the monetary union breaking up – by purchasing securities on the secondary market with no limits of time or quantity, forgoing the status of privileged creditor. As a result of the interdependence between fears of euro reversibility and fears for the sustainability of individual countries’ public debt, OMTs are conditional on precise public finance commitments and structural reforms within the framework of the ESM financial assistance programmes. The announcement brought success; even without actual intervention on the markets, it was instrumental in the drastic reduction of the part of the sovereign risk premium connected with fears for the euro’s survival: spreads have fallen to values closer to those consistent with the fundamentals, and markets are less fragmented. The yield spread between ten-year Italian and German government bonds has fallen back below 200 basis points. Bank of Italy estimates show that this improvement has been mainly due to the drastic reduction in the risk of the euro area breaking up. There have been signs of renewed interest in the Italian markets, including the government bond markets, reflected in a decline in the Bank of Italy’s debtor position in TARGET2, which fell to €190 billion at the end of February, almost €100 billion less than the peak registered in August 2012. These results would have been impossible without the start on resolving national imbalances and the reform of European governance. The single monetary policy cannot guarantee stability unless the economic fundamentals and the institutional architecture of the area are consistent with it. The risks are still present and tensions are ready to flare up again. In Italy the national component of the yield spread reflects high public debt and poor growth prospects; it needs to be reduced further: before the recession of 2008, for ten-year maturities this national component was less than 50 basis points. The reform of European governance has resulted in surrenders of sovereignty, albeit limited, on the part of all member states, in the areas of both fiscal and structural policy. Unconventional monetary policy measures were taken in response to the crisis. There is a legitimate need to examine the conformity of the solutions adopted with national constitutional law. Besides provoking a heated public debate, OMTs were scrutinized by the German Constitutional Court, which applied to the European Court of Justice for a judgment as to their legitimacy. The German Court argued that OMTs do not pursue a monetary policy goal in the strict sense, but since they have been used to safeguard the euro they have taken on a responsibility that properly lies with national governments; OMTs, it is held, overstep the ECB’s mandate, violating the ban on the monetary financing of budget deficits; they could also lead to a redistribution of resources among the countries of the area, thus achieving the same effect as a transfer system that is not envisaged by the European treaties. The aim of OMTs is to preserve monetary policy transmission in the euro area, which is jeopardized by distortions in the financial markets caused by the sovereign debt crisis. The goal is not to neutralize the spreads on the government bonds of specific euro-area member states in order to reduce their financial difficulties by interfering illegitimately with price formation in the market, but instead to reduce the components of spreads linked to factors independent of the financial sustainability of individual countries. Intervention does not aim to sustain the purchase of risky assets but to correct the misperception of that risk. The yield spreads between sovereign bonds observed at the moments of greatest tension were due only in part to market scepticism over the ability of individual member states to ensure the sustainability of their public finances and avoid a worsening of their credit risk. In large part, rather, they are explained by investors’ fears of euro reversibility. BIS central bankers’ speeches Lastly, the OMTs do not allow the ECB to buy government bonds whenever the monetary policy transmission mechanism is interrupted, but only when the interruption does not reflect a member state’s sustainability conditions. OMTs are never supposed to be used to purchase the securities of a country with unsustainable public finances. As regards the argument concerning the risk of resources being redistributed as a result of OMTs, the risk that would be incurred by forgoing them would be far worse. The way out of the crisis Exit from the crisis in the euro area cannot be achieved by the isolated actions of individual economic policy authorities. In particular, monetary policy alone cannot guarantee the financial stability of the euro area if the problems underlying the sovereign debt crisis are not resolved at national as at European level. The fragility of the public finances in some countries is the result of protracted fiscal imprudence and a culpable underestimation of the consequences of broad and persistent losses of competitiveness. Budgetary policy must ensure debt sustainability and full access to the market. The rules agreed at European level are the means, not the end. The real budget constraint for our country is given by the need to guarantee the sustainability of the public debt and to maintain full access to the financial market. As I have pointed out on more than one occasion, our Treasury’s annual resort to the markets is on the order of €400 billion. In a context still fraught with tension, it takes very little to undermine investor confidence. This is what happened between the summer of 2011 and the spring of 2012, when the share of Italian government bonds in foreign hands plummeted. The agreements concluded in the last two years have put the earlier budget commitments into practice. The rule on public debt, which will apply to Italy for the first time in 2016, calls for an average annual reduction of about one twentieth of the excess over 60 per cent of GDP. In order to comply, it is not necessary to lower the nominal size of the debt. In “normal” conditions of close to 3 per cent nominal economic growth, all that is needed is structural budget balance. Contrary to what some commentators say, a correction of €40–50 billion a year will not be required, nor will it be necessary to maintain a restrictive budget policy permanently. Although the debt rule does allow some room for flexibility, we must continue to aim for real growth in the economy, and hence the recovery of investment – which is at once a supply factor and a fundamental demand component. As to price developments, inflation is still below the level consistent with the ECB’s definition of price stability, i.e. an annual price rise of below but close to 2 per cent in the medium term. Actually, consumer price inflation in the euro area and Italy has fallen consistently more than expected in recent months and has kept below 1 per cent since October last year. According to recent estimates by the ECB, euro-area inflation will average 1.0 per cent this year, 1.3 per cent in 2015 and 1.5 per cent in 2016. Our forecasts paint a similar picture for consumer prices in Italy. We are not in a situation of generalized price reduction, of deflation. But even a long period of excessively small price changes can have undesirable consequences: it hinders the correction of macroeconomic imbalances through the adjustment of relative prices; it can prompt consumers to postpone purchases, especially of durable goods; it can affect the cost of capital thus deterring capital formation; and it makes debt service more onerous. If such a situation lasts too long, it can cause inflation expectations to become dangerously detached from the monetary policy. The risk of long-term inflation expectations no longer being anchored to price stability must be resolutely countered. This risk is limited for the time being, but there are signs that should not be underestimated. The downward trend in inflation expectations has sharpened in recent months, spreading even to more distant time horizons: the yields on inflation swaps BIS central bankers’ speeches indicate that the expected annual inflation rate is 1.2 per cent three years ahead and 1.6 per cent five years ahead. Professional forecasters surveyed by the ECB estimate a nearly 20 per cent probability that in two years’ time inflation will be 0.9 per cent or lower. The formation of expectations is a non-linear process; major changes can occur suddenly, almost without warning, making it more difficult to regain control. Against this background, the ECB’s Governing Council has reaffirmed its intention to maintain an accommodative monetary policy stance for as long as necessary and has firmly reiterated that policy rates will remain at present or lower levels for an extended period. In line with its mandate, the Council will use all the tools needed to maintain price stability. To accompany the reform efforts of individual countries, the ECB’s monetary policy commitment in its area of responsibility must be matched by the commitments of the other institutional actors. The debate on the euro area’s “fiscal capacity” launched by the Report of the President of the European Council and the Commission’s Plan was abruptly broken off after the Commission presented its plans for major economic reforms and for financial support to structural reforms in March last year. The delays in implementing structural reforms in many countries are responsible for the build-up of the macroeconomic imbalances that have fuelled the current crisis. The Commission’s proposals, expressly open to discussion in order to discover any scope for improvement, go in the right direction of identifying mechanisms to support the convergence needed to strengthen the Economic and Monetary Union. Italy must succeed in taking full advantage of all the opportunities offered by the Union. In the past, for example, we were not able to benefit fully from the European Structural Funds. Introducing structural reforms that help us to regain competitiveness is an essential step towards the country’s recovery. The measures that need to be taken have long since been identified. The process of European coordination could help to flesh out the details, but the ultimate responsibility for the reforms still lies with us. It is important to continue resolutely along the path to a fuller Union. The adoption of single mechanisms for banking supervision and resolution is a crucial step. The benefits of strengthening European integration far outweigh the alleged advantages of weakening it. Choices must be made responsibly. We cannot fear only the risks of action and disregard those of inertia. BIS central bankers’ speeches | bank of italy | 2,014 | 3 |
Concluding remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Ordinary Meeting of Shareholders 2013 - 120th Financial Year, Bank of Italy, Rome, 30 May 2014. | Ignazio Visco: Overview of economic and financial developments in Italy Concluding remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Ordinary Meeting of Shareholders 2013 – 120th Financial Year, Bank of Italy, Rome, 30 May 2014. * * * Ladies and Gentlemen, Since last autumn, monetary policy in the euro area has been faced with a scenario of very low inflation inconsistent with the objective of price stability, in a setting of persistently modest and uneven economic growth. Work directed to the launch of the Single Supervisory Mechanism in November has been stepped up and the advance towards the completion of Banking Union has continued. Substantial headway has been made in the full operation of the single euro payments area. In Italy, the road out of the most acute phase of recession has been rocky at times owing to political uncertainty. The recovery has not found a firm footing, making it all the more urgent to proceed with reform action. For the Bank of Italy, the most important change has been in ownership structure. Our commitment to modernizing the Bank’s organization and management systems has been strengthened, and operating costs have been further curbed. The results for 2013 permit us to submit to this Shareholders’ Meeting a proposal for the distribution of profits which, in addition to the allocation to the provision for general risks, calls for the assignment of adequate resources to reserves against the risks connected with the crisis. Taking market conditions into account, the proposal is for the distribution to shareholders of dividends amounting to €380 million, with the remaining €1.9 billion going to the State, in addition to taxes of €1.6 billion for the year. The reform of the Bank of Italy’s ownership structure, enacted by Parliament, involves technical complexities that have distracted public attention from the objectives that have been attained. The new arrangements maintain the model of shareholding centred on the financial industry, a feature shared with other major central banks. They reaffirm that shareholders have no power to influence the Bank in fulfilling its institutional functions. They supersede anachronistic and anomalous features that had developed over the decades. They make the process of profit distribution more transparent. And they clarify, circumscribing them, the shareholders’ economic and equity rights. Shareholders continue to have no claim on the Bank’s foreign exchange and gold reserves, whose public function is beyond question. The value of the Bank’s capital, which the law now sets at €7.5 billion (against 300 million lire established in 1936) is consistent with the estimate made by the Bank at the behest of the Government. This valuation, which had specified both a minimum and a maximum value, was endorsed by experts of undisputed competence and independence. The methods and the results were made public. The increase was accomplished by means of the transfer to capital of a portion of the statutory reserves, without affecting the Bank’s own funds and at no cost to the public finances. The reform avoids undue transfers of wealth to the benefit or detriment of the shareholders. Under the previous arrangement, in addition to dividends shareholders also received an amount proportional to the Bank’s statutory reserves, which were bound to increase indefinitely owing to the automatic reinvestment of the return on them and the allocation to reserves of a part of each year’s profits. Eliminating any claim to the statutory reserves, the new rules entitle the shareholders solely to a dividend drawn from net profits, up to a maximum of 6 per cent of the Bank’s capital, hence not more than €450 million. Amounts increasing over time with no limit have been replaced by a dividend that is higher initially but subject to a fixed ceiling. BIS central bankers’ speeches The concentration of shareholdings in the hands of the main banking groups fuelled the erroneous but persistent perception of possible interference in the Bank’s performance of our institutional functions. The reform has broadened the potential shareholder base, capped single institutions’ stakes at 3 per cent and instituted effective measures to foster a redistribution of shares to bring holdings down within that ceiling. We expect shareholders to act swiftly and on their own to dispose of their excess holdings. The rights associated with shareholding have now been defined with certainty, which favours trading in the shares and permits transparent price formation. We shall act to facilitate this process. The actual amount of dividends will be decided, each year, subject to the results for the year and the Bank’s capital needs. In order to foster compliance with the limit on shareholdings, the Bank may purchase its own shares temporarily; we shall avail ourselves of this option only if necessary and in such a way as in no case to entail any risk of loss. The newly acquired clarity concerning the amount realizable from sales of Bank of Italy shares and the prospect of market transactions make it possible to include them in the regulatory capital of banks and insurance companies, which could have a modest positive effect on the supply of credit. The shares do not form part of the banks’ initial capital for the asset quality review that the ECB is currently conducting together with national supervisors. The Bank of Italy: an institution open to change In performing its functions the Bank manages resources entrusted to it in the national and European interest, pursuing the express objective of efficiency. For some time now we have been engaged in an operation of reorganization and rationalization. The initiatives undertaken in this regard are described at length in our Relazione sulla gestione e sulle attività (report on operations and activities), which has a specific section dedicated to cost trends in the last few years. Relying on new technology, we have imparted impetus to the modernization of the payment system and made a sizeable investment in the computerization of our branches. Since the mid-1990s this has resulted in a steady diminution in the resources allocated to cashier and state treasury services. The reorganization carried out between 2008 and 2010 reduced the number of branches from 97 to 58, of which 31 have been converted into more streamlined, specialized units. The yearly cost of the branch network has been cut by about 25 per cent in real terms. A reassessment, open to the contribution of representatives of the staff, is now under way on the best way to guarantee the Bank’s efficient presence throughout the national territory. At the start of this year our head office was reorganized. In place of the old functional areas, we now have eight directorates general, with autonomous management responsibilities. The directorates with responsibilities for human resources have been unified. Procurement has been assigned to a single specialized unit. The number of units assigned to administrative tasks has been reduced. The total staff of the Bank of Italy, including the Italian Foreign Exchange Office personnel taken on by the Bank in 2008, has come down from a peak of over 10,000 in the early 1990s to 7,850 on the eve of the branch reform and to some 7,000 at present. Operating costs have been lowered by 14 per cent in real terms over the past four years. We will continue along these lines, carefully reviewing every expenditure item. Our ongoing reform action has lowered costs and improved efficiency, maintaining high quality service and capitalizing on staff skills. The reduction in resources employed and costs incurred has been achieved despite an increase in the number and complexity of the tasks performed. European integration, with the creation of the European Central Bank, has not resulted in any diminution of the responsibilities of the national authorities in the field of monetary policy or banking supervision; nor will it in the future with Banking Union. BIS central bankers’ speeches The ECB’s monetary policy decisions are taken collegially by the Governing Council, which consists of the governors of all the national central banks of the Eurosystem, acting in the European common interest and using for this purpose the research and analysis of their own institutions. The ECB’s own preparatory analytical work is conducted through the intense activity of committees and working groups that bring together experts from the various national central banks. Our capability for economic, statistical and legal research and analysis is also placed directly at the service of the nation, with advisory services and operational support to Parliament, the Government and other institutions, and with activity in international forums. The implementation of monetary policy is delegated wholly to the national central banks: open market operations, the refinancing of banks, and the acquisition, management and valuation of the collateral they provide in exchange for liquidity. The central banking function includes the production and distribution of banknotes. Our works print about 18 per cent of the euro area’s paper money, with a peak last year of 1.36 billion notes. The Bank of Italy regulates and controls the activities of banks and other cash handlers, with off-site analysis and on-site inspections involving its branch network. Our institution develops and manages the technological platforms and infrastructure for the clearing and settlement of domestic financial transactions. Together with the Bundesbank, we are entrusted with operating the euro area’s TARGET2 gross settlement system, to be flanked by the TARGET2 Securities system for the settlement of securities trades in the euro area, now under development. The Bank of Italy is the Italian national authority competent for the realization of the single euro payments area for retail transactions. The Bank and its branch network also manage the state treasury service. We exercise oversight of the payment system and financial market infrastructure in cooperation with our European counterparts. Together with Consob, we oversee wholesale trading in government securities and post-trading activities in financial markets. In November, with the launch of Banking Union, the Single Supervisory Mechanism created by the ECB and the national competent authorities of the participating EU member states will be operational. With the decisive contribution of the national authorities, the ECB will supervise banks identified as systemically important according to specific criteria, such as size. For Italy, this group should include nearly all the fifteen intermediaries currently subjected to the comprehensive assessment. The national authorities will maintain direct supervision over all the other banks – in Italy they number around 600 – according to common standards and methodologies to ensure uniform supervisory action. The Supervisory Board, which is charged with preparing decisions to submit to the ECB Governing Council, is already operational. It consists of representatives of the ECB and of the national supervisory authorities, including the Bank of Italy. Committees in which experts from individual countries can deal with issues of common interest are already active. The quality of European banking supervision will depend strictly on the contribution of the authorities that have had the most experience in this field. We are now actively working to ensure the adoption of best practices in the Single Supervisory Mechanism, collaborating within the European Banking Authority on the design of a Single Rulebook to ensure a level playing field. In order to participate effectively in the decision-making process of European banking supervision, we shall extend our analysis to the banking industry and the major banks in other countries. The launch of the Single Supervisory Mechanism will affect the daily activities of all the authorities involved. Off-site controls on systemically important banks will now be carried out by teams consisting of both ECB and national personnel. Inspections will be conducted by groups in which national staff may be flanked by members from other countries. The Bank of Italy is also entrusted with the prudential supervision of securities firms and asset management companies, financial companies, payment institutions and electronic BIS central bankers’ speeches money institutions. The Bank has full jurisdiction over all intermediaries, including banks, in matters of consumer protection and transparency. It is engaged in the promotion of better financial awareness on the part of the general public, in particular in schools. It will continue to provide assistance to the panels of the Banking Ombudsman for dispute resolution. Our branches contribute significantly to these activities. Financial stability requires a macroprudential commitment. In this context the Bank is a member of the European Systemic Risk Board and participates in the work of the Financial Stability Board and the G20 to complete a series of reforms to make the financial system sounder and more resilient. We have intensified our efforts to combat money laundering and terrorist financing, both within our directorate general for financial supervision and through the Financial Intelligence Unit, an autonomously managed body instituted within the Bank of Italy, which regulates the Unit’s operation and provides the necessary human, financial and technological resources. In January 2013 the new insurance supervisory authority (Ivass) was constituted, in close relation with banking and financial supervision. It is chaired ex officio by the Senior Deputy Governor of the Bank of Italy, who runs it together with two Councillors. Measures with significant external implications are decided on and issued by the Governing Board of the Bank enlarged to include the two Councillors. Cooperation between the operational structures of the two institutions is extensive and growing. The public functions assigned to us, which I felt it was appropriate to recall here today, require adequate technology and, even more, high quality human resources. The competence, motivation and commitment of individual staff members are essential to effective action and to the Bank’s reputation. We are taking steps to ensure that the Bank of Italy maintains its ability to attract talented young people who have successfully completed rigorous courses of study. We are well aware that we can still improve the organization of work, through reconsideration of the assignments and the professional development of individual employees, in fruitful dialogue with the trade unions. I join the Board of Directors and the Governing Board in thanking the staff of the Bank for the capability, spirit and dedication with which they perform their duties. The exit from the sovereign debt crisis: monetary policy, Europe, Italy Financial conditions have improved greatly in the euro area since last year. After Ireland, Greece and Portugal too are once again issuing government securities. Yields on Italy’s tenyear BTPs have fallen to 3.0 per cent, less than half the peak figure recorded in November 2011. The yield spread with German securities is now around 160 basis points; it had hit 550 points in November 2011 and was still 470 points in July 2012. The contribution of monetary policy has been crucial: during the most acute stages of the crisis it prevented the situation from precipitating; it helped allay investors’ fears for the integrity of the Economic and Monetary Union; it accompanied the implementation of important reforms at national level and in European governance. Since last summer there have been large inflows of capital from the emerging economies, mainly following the announcement by the Federal Reserve of its plan for tapering monetary accommodation. The resulting downward pressure on long-term euro interest rates could be transient; less expansionary monetary policy in the United States could provoke a rebound in global yields. Volatility on the financial markets in the advanced economies has subsided to well below the historical norm, reaching levels that in the past sometimes preceded rapid changes in the orientation of investors. The fluctuations in government securities yields in recent weeks remind us just how sensitive the markets can be to any signs of uncertainty. The consolidation of the public finances in the countries hit by the crisis, necessary per se and imperative to eliminate any doubts about debt sustainability, constitutes a guarantee against the rekindling of tensions on the sovereign debt markets in the euro area. However, BIS central bankers’ speeches the combined costs of the recession and restrictive budgetary policies have been high. The economy and, in particular, the labour market remain fragile. Structural reforms make our economies more resilient to future shocks, but it will take time for them to yield their full fruits. Income support for those worst hit by the crisis and reemployment mechanisms for workers forced out of traditional production work can make a contribution. In addition to expansionary policies in the countries where the public finances allow it, concerted action at European level could help to boost investment and consumption demand. The opportunities provided by favourable external conditions must not be missed; the conditions for transforming the capital now available into lasting productive investment have to be guaranteed. Monetary policy and Europe Monetary policy in the euro area now faces challenges somewhat different from those addressed over the last two years. Economic activity returned to growth in 2013, but only in part of the euro area and at very uneven speeds. The most recent data confirm this. Credit market conditions remain difficult. Financial fragmentation along national lines has diminished but it has not disappeared. Above all, there has been a sharp reduction in consumer price inflation; since the middle of last year the rate of inflation has been well below the ECB Governing Council’s definition of price stability. During 2013 we lowered the official interest rates twice, in May and in November, bringing the cost of the main refinancing operations to an all-time low of 0.25 per cent. In July we began to provide explicit indications of our monetary policy stance, announcing that the official interest rates would remain at or below the then current level for an extended period, in consideration of the outlook for inflation, the weakness of the real economy, and monetary and credit dynamics. This forward guidance attenuated the volatility of short-term interest rates. The rapidity of the fall in inflation has surprised the main forecasters, who have revised their short- and medium-term expectations downwards. This pattern has been more pronounced in the countries directly hit by the sovereign debt crisis, but it is common to the entire euro area. It reflects not only the fall in energy prices, compounded by the appreciation of the euro, but also the persistent weakness of the economy. Core inflation has fallen to its lowest levels since the introduction of the single currency. Just like excessively high rates of inflation – and we can still well remember how difficult it was to overcome that problem more than twenty years ago – prices that are growing too slowly are also detrimental to financial stability, especially when public and private debt is high and growth is weak. Excessively low inflation must be countered with equal firmness, also to prevent it from being incorporated into medium-term expectations. The formation of expectations is not a linear process: even large changes can materialize very quickly, discontinuously. Since July 2012 the euro has appreciated by an average of 9 per cent against a basket of other currencies; against the dollar it has gained 12 per cent. The appreciation began following the announcement of Outright Monetary Transactions, which allayed fears about the reversibility of the single currency that had turned investors away from financial assets issued in some euro-area countries. The exchange rate is not in itself a monetary policy target, but at this stage the euro’s appreciation has compressed consumer price inflation, both directly, by reducing the prices of imported goods, and indirectly, by increasing competitive pressure on domestic products. Eurosystem inflation projections will be made public on 5 June. According to those published in March by the ECB, inflation is expected to remain well below 2 per cent over the next two years. This is not consistent with our definition of price stability. If this pattern is confirmed, BIS central bankers’ speeches the Governing Council is determined to act, even with unconventional policies, to ensure that in the medium term price developments do not diverge from the desired path. Albeit in a situation of emergency, and not without some hesitancy, European policies have achieved significant progress during the crisis: the strengthening of fiscal rules, the extension of multilateral surveillance to macroeconomic imbalances other than those of public finances, the establishment of common funds for financial assistance to countries in difficulty, and the launch of the Single Supervisory Mechanism. As I have observed on other occasions, the euro is a currency without a state and suffers from this deficiency. To complete the journey towards integration other essential elements of sovereignty need to be shared; Banking Union, now being implemented, should be followed by the creation of a true common budget. Designing instruments that will make it possible to intervene in support of economic growth and better public welfare would help the European Union to regain the consensus that has been partially lost. In the shorter term, the central bank can support domestic demand through the pursuit of monetary stability. But the return to sustained and balanced growth requires broader economic policy action at European level. Measures must be taken immediately to speed up the creation of infrastructure, both tangible and intangible, indispensable to the formation of a true single market. Joint intervention would help to give market expectations a positive orientation. The Italian economy In Italy, the long recession in progress since 2008 with only a brief interruption came to a halt at the end of last year, mainly thanks to foreign demand and to the reduced need for fiscal adjustment. A contribution came from the accelerated payment of general government commercial debts. A real recovery is struggling to get under way, however. The gradual improvement in expectations has been slow to translate into a solid upturn in economic activity. The recession has left a burdensome legacy. Many Italian companies have managed to safeguard their shares of foreign markets and some have increased them; the current account is back in surplus, even on a cyclically adjusted basis. But the contraction in domestic activity has been dramatic: industrial production has shrunk by 25 per cent overall. In the last quarter of 2013, while exports were almost back to the same level as at the end of 2007, household consumption was still down by about 8 per cent and investment by 26 per cent, with a capacity loss in manufacturing of approximately 15 per cent. Although there are signs that confidence is picking up, the need to compensate for the erosion of accumulated savings and uncertainty about prospective income in the medium to long term will continue to weigh on household consumption. Household spending can benefit from the recently approved tax cuts, but it will not become the driving force of the recovery without an enduring increase in employment. The recession has had a heavy impact on the number of persons in employment and hence on household income. Between 2007 and 2013 employment fell by more than a million, with almost all of the contraction in industry; the average number of hours worked also decreased. The unemployment rate has more than doubled compared with the low point of 2007, reaching 12.7 per cent in March. The supply of jobs will only begin to rise slowly; usually the first variable to react to an increase in output is the number of hours worked per employee. We must not underestimate the risk that a further lengthening of the duration of unemployment – and there are signs of this particularly in the South and among the younger population – may erode individual skills and know-how and distance them from those that firms require. In the past, deep recessions have been associated with extensive restructuring of the productive system that has resulted in the introduction of new labour-saving BIS central bankers’ speeches technologies and organizational models. But the crisis can be the occasion for our firms to carry out and extend what up to now has often been missing: a profound renewal of the mode of production in connection with the digital revolution, which can give life to new forms of enterprise and employment in new fields of activity. Productivity gains and employment growth can go hand in hand if domestic demand revives. The key is the growth of fixed investment, which forms the linkage between demand and supply. On the one hand, given the right external conditions, investment is the demand component that reacts most promptly to changes in expectations, while on the other it bolsters supply capacity by exploiting technical progress and responding to the globalization of markets and production processes. The ratio of gross investment to GDP has fallen by 4 percentage points since 2007, reaching a post-war low of 17 per cent in 2013. The difficulty of many firms in accessing bank credit has been a factor. But it is above all the widespread uncertainty over the prospects for demand growth and the orientation of economic policies that is responsible for postponements and cutbacks of plant restructuring and expansion plans. Towards the end of 2013 opinions of the conditions for investment became more favourable, especially among the largest companies. In manufacturing industry, spending plans suggest a stabilization this year, thanks to the support of the capital goods component. These first positive signs can strengthen if the business environment improves. Economic policy measures that act on both the demand and the supply side in a comprehensive, consistent framework can support economic activity in the short term and lend strength to the reform project. If that project is vast, vigorous and credible, it can alter the course of expectations, reinforcing the growth of investment, employment and consumption. The response to the acute phase of the crisis was notable, but the results have suffered from the fragmentary nature of the interventions and from the incomplete implementation of many of the measures adopted, in some cases owing to successive, at times substantial revisions made to them soon after. It is important to build on the foundation of what has already been done. For example, thanks to the measures in the service sector, the OECD indicators show that Italy is now more open to competition. But at the end of last year only half of the implementing measures envisaged by the 69 reform laws passed between November 2011 and April 2013 had been issued. In the field of taxation, the rapid implementation of the enabling act can ensure greater certainty in the application of rules and sanctions and make the fight against tax evasion and avoidance more effective and closely targeted. The main shortcomings of our economic system and the prospects for reform, which are also the subject of the National Programme that the Government presented in April, are examined in a chapter of this year’s Report. The list of areas requiring action is long; among the most urgent interventions are those to safeguard legality and efficiency in the public administration. Corruption, criminal activity and tax evasion not only undermine the community but also distort the behaviour of economic agents and market prices, reduce the effectiveness of governmental action, increase the tax burden on those who do their duty, and compress productive investment and job creation. A well-functioning public administration improves the operation of markets and competition, reduces firms’ costs, and is reflected in the quality and cost of public services and thus on the tax burden. The efficacy of the reforms depends on it. Restrictive regulation and a legal and institutional environment that is unfriendly to entrepreneurial activity hamper the transfer of resources towards the more efficient firms and sectors and the growth of productivity. The same elements also affect the Italian economy’s ability to attract investment from abroad, which is very poor compared with other economies, ultimately curbing the diffusion of innovative technologies and managerial practices. For BIS central bankers’ speeches potential investors, both Italian and foreign, the lengthiness and complexity of administrative procedures pose the most significant obstacle. In many cases the benefits of reforms are inevitably deferred. This is true, for example, of interventions on the education and training system, a subject to which we have dedicated another chapter of the Report. But this is no reason to postpone action. The level of education and skills on which the Italian productive economy can count is inadequate: a recent OECD survey ranks Italy last for functional literacy and next to last for numeracy; the gap with the average of the other countries is also found among the younger age groups and increases with the level of educational qualification. Important progress has been made in adjusting the public finances. The deficit is equal to 3 per cent of GDP, below the European average. With Germany, Italy has the highest primary surplus in Europe, and Italy is close to achieving structural budget balance. The reforms of the past years have reduced the pressure of demographic trends on public expenditure, pressure which instead remains strong in many other countries of the Union. The lowering of the ratio of debt to GDP remains the ineluctable challenge for our country; its speed depends on a return to stable, rapid growth. Economic growth and budgetary balance can only be pursued in tandem. The results won with so much sacrifice must not be squandered. They make it possible to undertake actions in support of growth, for example by continuing to shorten the payment times of general government entities and to reduce the tax wedge on labour. The budgetary rules that we have agreed in Europe and transposed into our national law are aimed at ensuring the long-term sustainability of the public finances. The margins of flexibility that they afford can be exploited as part of a cogent strategy of structural reforms directed at clear and credible objectives. Careful action to recoup efficiency in the public administration, conducted as part of the spending review, can assist a reallocation of expenditure to the benefit of the more productive items. This objective should be accompanied on the revenue side by greater reliance on the less distortionary items at both central and local level. The endowment of infrastructure, in which Italy is inferior to the other main European countries, influences firms’ productivity, their choices of where to locate and the quality of life of the population. The delays accumulated in the past decades reflect not so much insufficient resources as inefficiency in their use, but in the last four years public investment expenditure has diminished by nearly 30 per cent. European resources and private capital can contribute in greater measure to the financing of infrastructure and territorial protection, with benefits for the building industry, which has been hit especially hard by the recession. Banks, credit, supervision In Italy, more than in other countries, the banks play a central role in financing the economy. Their business is concentrated in the traditional intermediation of savings, mostly within the country. This is one reason why they withstood the initial impact of the crisis, which originated in foreign markets and speculative financial products. In recent years, however, they have been badly hit by the protracted recession and the sovereign debt crisis. Our Annual Report details the role of the banks in the intermediation of Italians’ savings; the Report on Operations and Activities describes the supervisory action of the Bank of Italy. Bank loans to households and firms at the end of 2013 exceeded €1.4 trillion and 90 per cent of gross domestic product. Credit accounts for almost two thirds of firms’ financial debt. More than one third of households’ financial wealth is invested in bank deposits and bonds. In recent years the exceptional decline in GDP has undermined the soundness of many firms, increasing their debt-service burden. The repercussions for banks have been very BIS central bankers’ speeches serious: loan losses accumulated since 2008 amount to €130 billion; those in the past two years have absorbed almost all of banks’ operating profits. Banks have stemmed the deterioration of profitability by curbing costs. Between 2008 and 2013 the number of employees in banking was reduced by 30,000 and 2,400 branches were closed. The cost-to-income ratio was lowered from 66.7 to 62.1 per cent. Following the collapse of funding on the international markets in autumn 2011, extensive resort to the Eurosystem’s three-year refinancing operations enabled Italian banks to sustain a volume of lending to the economy that exceeded domestic funding and to meet the future redemption of bonds previously placed in foreign markets. With large-scale purchases of government securities the banks built up resources to withstand new liquidity crises, at a time when the increase in sovereign risk was driving foreign investors away from Italian markets. Interest income and capital gains on these securities partly offset the heavy losses on loans to households and firms. In mid-2013, with the return to orderly market conditions, banks began to sell off government debt. The financing of the economy Total credit to the Italian economy is shrinking. But the aggregate data mask different trends for the various categories of borrower. Given the persistent uncertainty about the timing and strength of the recovery, businesses have lowered their demand for credit. The largest firms have increased their recourse to the bond market. In 2013 gross placements by Italian issuers were close to €40 billion, almost twice the amount recorded in the years preceding the crisis. Credit supply restrictions are hardest on small and medium-sized firms, generally more risky and now especially weakened by the recession. In this setting the funding difficulties of firms with good growth opportunities but no direct access to the capital markets are a cause for concern. In the coming weeks the Bank of Italy will adopt measures to improve banks’ liquidity further, thereby facilitating lending to small and medium-sized firms. The range of loans eligible as collateral for Eurosystem refinancing will be extended. Innovations in the characteristics of contracts will enable banks to pledge new types of loan such as credit lines that are widespread among small firms. Banks will be allowed to use loan portfolios with more flexible collateral management and with lower haircuts; it will be possible to include mortgage loans to households. The chief obstacle to the supply of financing continues to be credit risk. Non-performing bank loans, net of provisions, have risen to 10.0 per cent of total lending; bad debts alone account for 4.0 per cent. At a time when banks are deeply concerned about borrowers’ soundness and prospects, the dearth of credit has been alleviated by the granting of government guarantees. In 2013 the Central Guarantee Fund accepted more than 77,000 applications to guarantee loans amounting to almost €11 billion. Recent measures have expanded the range of potential beneficiaries of the Fund and more than doubled, compared with the previous period, the resources allocated for the three years 2014–16. A portion of these resources has nevertheless been earmarked for purposes other than those originally envisaged. They must not be dispersed: the piecemeal nature of the interventions risks reducing the effectiveness of an instrument whose purpose must continue to be to facilitate access to credit for small and medium-sized firms that have been weakened by the recession but are fundamentally sound. A recovery in the securitizations market could help reactivate the flow of credit to the economy. Enabling investors to make an informed assessment of these transactions requires rules that increase their transparency and standardization, and distinguish between complex BIS central bankers’ speeches and simple products in favour of the latter. The European Commission recently announced initiatives that move in this direction. Italian firms’ indebtedness and dependence on bank credit are signs of their financial vulnerability. With almost €1.3 trillion in financial debt and €1.6 trillion in net equity, Italian firms’ overall leverage is 44 per cent; bank loans account for 64 per cent of the total debt. For the euro area these ratios are considerably lower, averaging 39 and 46 per cent respectively. A larger endowment of equity capital could facilitate firms’ access to credit. This, together with greater diversification of the sources of external funding, would make them stronger. Bringing financial leverage into line with the European average would require a capital increase of around €200 billion and an equal reduction in debt: this is an ambitious objective but one within the reach of Italian firms in the medium term. Structural reforms to kick-start growth would attract equity-type funds from external investors and encourage entrepreneurs to invest their own resources, thereby being the first to show confidence in their firms’ prospects. Firms’ funding model reflects the structural traits of Italy’s economy, such as the modest size and family-based ownership of businesses. Entrepreneurs are reluctant to admit new partners or to raise funds directly on the market, partly owing to a taxation system that has long done little to favour equity capital. The capital-building incentive introduced by Decree Law 201/2011 (the Allowance for Corporate Equity), reinforced by the 2014 Stability Law, corrects the tax disadvantage of equity with respect to debt. It represents an important opportunity for all firms; it is estimated that almost 40 per cent of firms with 20 or more workers increased their capital in 2012–13. Supervisory action In 2013 the Bank of Italy continued the verification of the adequacy of loan loss provisions that we initiated in mid-2012. The supervisory authority continued to call on banks to strengthen their capital in order to ensure their solidity. At times our interventions have been harshly criticized. We believe that they were decisive first to preserve and then to reinforce investors’ confidence in the banking system’s ability to withstand the impact of the crisis. Thanks in part to this action, in 2013, notwithstanding the sharp increase in non-performing loans, the coverage ratio on them went up from 39 to 42 per cent. Core tier 1 capital rose from 7.1 per cent of risk-weighted assets in 2008 to 10.5 per cent in 2013; substantial issues of new equity and retained profits contributed nearly €60 billion to the increase in capital. Capital strengthening proceeds: in the first five months of this year ten banking groups made or announced capital increases amounting to €11 billion; for the banks subject to the comprehensive assessment carried out at European level this will raise capital ratios by around one percentage point. Capital strengthening has been achieved almost entirely with private capital. The Italian State’s contribution has been minimal; it reached €4.8 billion in the first quarter of 2013 (0.3 per cent of GDP), a level far below those of most of the other European countries; it will be wiped out by the repayment of the State’s loan to Monte dei Paschi di Siena, of which €3 billion has already been authorized by the Bank of Italy. Overall, public support for the banks has generated substantial net gains for the Italian State. The banking foundations have participated in capital-raising operations, thereby contributing to the solidity of the banking system in the most difficult phase; sometimes, as a matter of choice or out of necessity, they have reduced the share of capital they owned. The inflows of resources connected with investors’ renewed confidence in Italy’s prospects provide an opportunity for banks to strengthen their capital bases and for foundations to further diversify their assets. At the same time it is necessary, as I have indicated on several occasions, to BIS central bankers’ speeches reinforce the separation between foundations and banks by prohibiting persons from moving between the governing bodies of foundations and banks and extending the ban on control to cases in which it is exercised de facto, even jointly with other shareholders. For many small and medium-sized banks close relationships with their home territory are a source of stability, which has a beneficial effect on the local economy. However, a misguided interpretation of these relationships can distort the disbursement of credit, thereby jeopardizing the soundness of banks’ balance sheets and the efficient allocation of resources. Cases of this kind become more likely during prolonged recessions, such as the one we have passed through. We are working to persuade banks to strengthen their operational, organizational and corporate governance safeguards in order to prevent credit relationships with customers from degenerating and to take remedial action when they do. Taking account of the numerous suggestions deriving from public consultation, the Bank of Italy has recently issued regulations on bank governance. The rules foster the correct exercise of the functions of strategic guidance, management and control, enhance the functionality of decision-making chains, exert downward pressure on costs, and make directors more accountable. Some of the rules are immediately applicable, others could require banks to make changes to their bylaws, to be implemented without delay. The innovations introduced for cooperative banks encourage shareholders to attend shareholders’ meetings, foster internal debate and facilitate the raising of equity capital. Bank crises are often associated with weaknesses in corporate governance systems, which sometimes breed episodes of malfeasance. The Bank of Italy tackled 11 new cases of intermediaries in difficulty in 2013 and another six in the first four months of this year. The banks currently under special administration are small or medium-sized; they account for about 1 per cent of the total assets of the banking system. Since 2009, ten intermediaries have been placed directly in liquidation and 55 under special administration; about half the crisis procedures that have been completed saw the banks return to ordinary operations, including by way of takeovers. The continuity of customer services was guaranteed together with the protection of depositors. In the last two years 340 inspections were carried out at banks that accounted for 80 per cent of the banking system’s total assets. In 63 cases serious shortcomings were found in banks’ corporate governance. In 45 of these there were irregularities of a possibly criminal nature that were promptly reported to the judicial authorities. With the proper distinction of functions and instruments, cooperation with the magistracy is intense. Where necessary the Bank of Italy requests banks to radically renew their board of directors, strengthen their organizational structure and capital base, and draw up new business plans. This makes it possible to avoid recourse to crisis procedures, which might be required if the problems found persisted. Our action would become even more effective with the attribution of the power to remove a bank’s directors when necessary and on the basis of convincing evidence, as is envisaged in the draft law for the transposition of the European Capital Requirements Directive. Italy’s large banks, as well as granting loans, often hold equity interests in non-financial firms. Such shareholdings must not distort lending decisions or delay the emergence of borrowers’ difficulties. The risks associated with these relationships, in the same way as for those deriving from dealings with counterparties closely related to banks, must be carefully monitored by the latter’s governing bodies. The Bank of Italy cannot and must not assess individual lending decisions in advance, but lays down rules for related-party transactions and checks that they are complied with. The rules are intended to prevent allocative distortions and minimize conflicts of interest; they establish quantitative limits to risk, strengthened decision-making procedures, organizational safeguards and obligations to inform the supervisory authority. BIS central bankers’ speeches Banking Union and the implementation of the Single Supervisory Mechanism The ongoing construction of the Single Supervisory Mechanism is driving forward the Banking Union project, one aim of which is to counter the fragmentation of the euro area’s financial markets. The new European supervisory system shares the basic principles of the approach followed in Italy: emphasis on close integration of on- and off-site controls, quantitative and qualitative assessment of risks, and close linkage between the results of analyses and remedial action. The Single Resolution Mechanism for crises will come into operation in 2015. The handling of banking crises will involve numerous national and European institutions participating in the context of a Single Resolution Board. Provision is made for recourse to a fund made up of contributions paid in by the banks themselves. Even though the decision-making process appears complex and the pooled resources limited, the compromise reached is a further step towards the completion of Banking Union. Together with the ECB and the other national supervisory authorities, we are now conducting the comprehensive assessment of the most important euro-area banks. The aim of the exercise is to increase the transparency and reliability of banks’ balance sheets and increase the market’s confidence in the soundness of the European banking system, thereby contributing to the recovery of lending to the economy. The key aspects of the comprehensive assessment are an asset quality review and a stress test of the banks’ balance sheets. The exercise under way is of unprecedented complexity, both in terms of the volume of activities to be carried out and for their concentration in time. It considers a wide range of bank assets, going from loans to households and firms, to government securities and complex financial instruments, so-called third-level assets. In the cases where the assessment shows that a bank needs to raise its capital ratios, this can be done in several ways, ranging from not distributing profits to the disposal of nonstrategic assets, the cutting of costs and the issue of new equity. The manner of carrying out these interventions and their timing will be determined in relation to the nature of the capital weakness and according to whether it derived from value adjustments to balance-sheet items or from the results of stress tests. Capital-raising measures will have to be agreed with the national supervisory authorities. The credibility of the exercise and its success in restoring confidence in the soundness of the European banking system require that instruments of public intervention be available to act as financial backstops, as established by the European Council in June 2013 and reaffirmed by the Ecofin Council in November. They will have to conform with the basic principles of national and European law, with the ultimate objective of ensuring financial stability. The results of the comprehensive assessment of banks’ balance sheets will be published in October. The exercise is already making a contribution to the strengthening of banks’ capital bases. The effects on the supply of credit in the short term will need to be carefully monitored. In the longer run, the positive relationship between banks’ capital and growth in lending will be reinforced. The challenges immediately ahead In the closing months of last year the flow of new bad debts began to diminish. However, historical experience teaches that economic recovery will improve credit quality only gradually, and with a lag. To cope with the additional loan loss provisions that will be necessary, the banking system will have to increase its efficiency further. The rationalization of the branch network is beginning to make a dent in operating costs, but there is still ample room for improvement in the use of technology. The European-wide intensification of competition in the banking market that will stem from the shift to single BIS central bankers’ speeches supervision will stimulate a rethinking of banks’ business models, organization and distribution methods. The structural measures on banking now under discussion at European level can work in the same direction, with effects circumscribed to a limited number of banks. Mergers based on solid economic foundations and market logic can facilitate the recouping of efficiency. In considering proposed mergers, the Bank of Italy weighs their compliance with the regulations and with the standards of sound and prudent management. Banks must reduce the volume of non-performing loans in order to free up the resources needed to finance the economy. There is growing interest in these assets on the part of specialized investors, who are now willing to pay higher prices than in the past thanks to the easing of the sovereign debt crisis and the reduction in risk premiums. The revival of this market also benefits from the increase in provisioning, which translates into a decline in the prices at which banks are prepared to dispose of these loans. The market is also gaining from the recent changes in the tax treatment of loan losses, which have reduced – but not eliminated – Italy’s strong fiscal disincentives to the prudent valuation of risk. Some disposals of non-performing assets have already taken place, and others may be wellreceived by national and international investors. Several large banks are acting to rationalize their management of non-performing loans by creating special units for the purpose. The need to shrink the stock of impaired loans arises also for smaller banks, which could find it hard to develop autonomous strategies for dealing with them. *** The year 2013 was another trying one for Europe and for the Italian economy, harder than had been predicted twelve months back. The exit from the recession remains laborious, the recovery fragile and uncertain. In Italy, as elsewhere, there is no lack of positive signs: capital inflows are growing, consumer confidence is strengthening, manufacturing orders are rising. In order to consolidate these gains, it is necessary to build on what has been done so far, moving vigorously ahead on the path of reform and promoting the drive for efficiency in public services as in the private sector. We also know that gains in productivity, stagnant for too long, must be accompanied by the expansion of demand, and hence the growth of household income, which has to be sustained by the formation of new jobs. Investment – private and public, Italian and European – is essential. The union of the nations of Europe, whose fullest expression to date is the euro, is a work in progress that the peoples of the continent must be able to believe in, to recognize as the source of peace and prosperity. What is asked of the institutions is policies to make the European construction robust but that also respond to the challenges of our time. We are all citizens of this Europe, and together we must make it grow – and not only in economic terms. In the face of public opinion that is divided, not always well informed, the need is for profoundly European policies, implemented within the limits of national responsibilities but in the spirit of cooperation. Monetary policy and Banking Union are two key areas in which the Bank of Italy is intensely engaged. In monetary management the primary objective is price stability. Monetary policy as such cannot stimulate productivity or determine growth paths. But these are premised upon stable monetary conditions, which the Governing Council of the ECB is striving to ensure. As for banks, which are now subject to common rules and single supervision, in Italy they remain the fundamental pillar for financing the economy. For them to continue raising capital and borrowing in the markets, which is indispensable to the performance in full of their intermediation function, their governance must be strengthened, integrity of conduct must be guaranteed, and profitability must be increased. The possible repercussions of taxation and other burdens on their ability to compete in an integrated financial market must be weighed carefully. The recovery of the economy and renewed creation of jobs depend on the ability to finance deserving investment projects. Even in the present difficult phase, this is the fundamental task to be performed by bank credit, with the crucial support of capital invested directly in BIS central bankers’ speeches firms and resources procured in the market. Compliance with the rules and transparent conduct are essential conditions, and we shall continue to monitor them. The path to recovery – economic and beyond – will be neither short nor easy. Uncertainty is intrinsic to the rapid transition towards a radically different world, more open and mobile, in which protections for the vulnerable must go hand-in-hand with opportunities for young people. Ambitious policies need to be embodied in a clear, comprehensive set of actions. Investors, workers and consumers must be presented with a programme that takes due account of all the aspects of society and the economy that need to be reformed, fosters innovation, inculcates observance of the law, adheres to the principles of efficiency and equity, and rewards merit and responsibility. Although single measures may come at different times, not just for budgetary reasons, the visibility of such a coherent design will reassure citizens and bolster faith in the future, without which all progress is inconceivable. BIS central bankers’ speeches | bank of italy | 2,014 | 6 |
Remarks by Mr Fabio Panetta, Deputy Governor of the Bank of Italy, at the Netherlands Bank (De Nederlandsche Bank), Amsterdam, 10 June 2014. | Fabio Panetta: On the special role of macroprudential policy in the euro area Remarks by Mr Fabio Panetta, Deputy Governor of the Bank of Italy, at the Netherlands Bank (De Nederlandsche Bank), Amsterdam, 10 June 2014. * * * Introduction I would like to thank Klaas Knot and De Nederlandsche Bank (DNB) for inviting me to this seminar. It is a pleasure to be here, and to carry on our discussions of the challenges associated with the implementation of macroprudential policy (MAP). Policy-makers around the world have been engaged in recent years in a wide-ranging debate on the potential role of the new, as yet broadly untested, MAP regime and its connection with two other regimes that share similar features but have a much longer history, namely microprudential policy (MIP) and monetary policy (MP). The fact that MAP is or will soon be operational in many advanced economies does not diminish the importance of continuing this debate, especially in the euro area, which is in many ways a natural laboratory to study the challenges posed by MAP. First, euro-area economies rely heavily on bank credit to finance the real economy. Second, their banking markets have become increasingly concentrated in recent years, and might become more so in the future as a consequence of market pressures and banking union. Third, the euro area is subject to a single MP regime, but its stance cannot take into account the heterogeneity among member states and its transmission mechanism has been weakened by financial fragmentation. Finally, major changes are taking place on the institutional side for both MIP and MAP, with an increased centralisation of functions within the ECB, but also a notable retention of responsibilities at the national level. I will argue that this state of affairs has two main implications. The first one is that MAP is likely to be particularly important and powerful in the euro area. The second one is that its interaction with MIP and MP raises issues – opportunities as well as difficulties – that are specific to the euro area and in many ways more delicate than those faced by policy-makers elsewhere. In particular, an open dialogue between micro and macroprudential regulators is absolutely essential in this respect, especially today: our handling of the interplay between MAP and MIP is setting a precedent and shaping public expectations on how the two policies will work in the future, so any opacity on what we are doing, or why we are doing it, could be extremely damaging. In the following paragraphs I will first recall three key factors that make the euro area’s case special: high reliance on banks (Section 2); heterogeneity and fragmentation (Section 3); and concentration of the banking system (Section 4). I will then comment on “what to do next” (Section 5) and discuss some of the practical challenges surrounding the implementation of MAP (Section 6). The thread running through the arguments, to which I will come back in my concluding remarks, is that MAP can certainly play a prominent role in the euro area, both structurally and in today’s situation, and that special care must be taken in operationalising it to exploit the synergies with MIP and MP. 1. High reliance on banks One key common denominator of the euro-area economies is that they rely heavily on bank finance. Financial markets and non-bank intermediaries are less developed than in the US or the UK, and typically do not fully compensate for shifts in the supply of bank credit. BIS central bankers’ speeches The MAP toolbox is generally thought to operate mainly through the banking sector; this is certainly the case for most of the instruments that we are beginning to explore following the introduction of the Basel III and CRD-IV-CRR regulation.1 Hence, the regime could be both more powerful and more important here than in market-based economies. If a variation in MAP capital buffers had a broadly similar impact on the supply of bank credit in the US and in the EA, I would expect its impact on total credit to be stronger in the EA, where non-bank credit is both smaller and relatively less elastic. The linkage between capital buffers and aggregate credit gaps is also likely to be stronger in bank-centric economies. Other things being equal, this will tend to make the risks and potential gains from using countercyclical capital (or liquidity) buffers greater in the EA than elsewhere. The structure of the financial system is endogenous (it reacts to changing regulation), so MAP policies focusing on banks may ultimately affect markets or the shadow banking sector.2 In the medium term, however, the structure of financial markets in the EA can arguably be taken as given, so that high reliance on banks implies a more powerful transmission of MAP. 2. Heterogeneity and fragmentation The second distinctive factor of the euro area has to do with the heterogeneity among member states. The business cycles of national economies are not synchronous; real and financial markets are not completely integrated, despite significant progress since 1999. The fragmentation of European financial markets has a structural dimension: many European banks operate mostly in retail markets, which are by nature local markets. Furthermore, cross-border bank penetration has always been relatively low in Europe.3 This has placed severe strains on the MP transmission mechanism. With macroeconomic outlooks that (in general) differ widely among member countries, and a monetary transmission mechanism that (as of today) works in a strongly asymmetric fashion – and is least effective precisely where it is most needed, namely in the periphery – the value of introducing policy tools with a national focus is considerable. In this environment, country-specific MAP regimes can be used not only to enhance financial stability but also to prevent financial and possibly real imbalances stemming from the “one size doesn’t fit any” problem that may at times be associated with MP. This point is intuitive, but it can also be formalised, showing that MAP rules can reduce macroeconomic volatility and improve aggregate welfare.4 We have plenty of evidence, both before and after the crisis, of discrepancies in real and financial cycles among euro-area countries. As an example, let us consider bank lending to firms and households during the last decade (Figure 1). Germany, France, Italy and Spain all started off in 2000 with ratios of corporate loans to GDP in a relatively narrow range between 35 and 45 per cent (panel A). Over the following ten years, however, the ratio declined in Germany, remained constant in France, increased in Italy, and literally ballooned in Spain. This diversity also appeared in household credit (panel B) and house prices (panel C). Countercyclical capital buffers and risk weights are obvious examples of bank-focused MAP instruments. On the market side, one could think instead of restrictions on specific transactions (e.g. short selling). Panetta (2013b). From 2007 on, foreign banks accounted for 9% on average of the total number of active banks in France, Germany, Italy, Spain and held only 6.5% of total bank assets. By contrast, in the United Kingdom foreign banks accounted for 57% of the total headcount and held 14% of total bank assets. For the US, the figures are 28% and 23% (Claessens and Van Horen, 2013). Banks’ foreign credit claims in euro-area countries declined significantly as a consequence of the financial crisis (see Bologna and Caccavaio, 2014). Angelini, Neri and Panetta (2014) examine the gains from coordinating MP and MAP in a closed economy. Brzoza-Brzezina et al. (2013) extend the analysis to the case of two countries facing asymmetric shocks but subject to the same MP, and find that country-specific LTVs and capital buffers have significant stabilising effects. BIS central bankers’ speeches Evidence suggests that a set of country- and/or sector-specific MAP measures could have been used in the run-up to the crisis to limit the emergence of imbalances. In fact, the crisis emphasised that policy-makers should be concerned with the whole distribution of future economic outcomes.5 Some argue that MP could take an active stance in cases where inflation is on target but financial imbalances generate large upside or downside risks around its expected path.6 In any case it is clear that, in dealing with situations of the kind just illustrated, targeted MAP tools are a powerful complement – possibly an alternative – to a “lean against the wind” MP stance. To the extent that credit booms, or excessive concentration of exposures within specific sectors in specific countries, stem from externalities among banks, MAP clearly has the potential to usefully complement a pure MIP regime.7 Many commentators have indeed pointed to strategic complementarities – a specific form of externality by which the pay-offs associated with a bank’s decision are positively affected by the number of banks that behave in the same way – as one of the key drivers behind the financial exuberance of the early 2000s.8 Given its focus on the solvency of individual institutions, MIP did not historically, and probably could not in general, respond to these types of behaviour. Instead, MAP could have discouraged, for instance, excessive mortgage lending through higher LTVs on real-estate loans, or a disproportionate reliance on wholesale funding through an NSFR-type instrument.9 Crucially, these would have operated across the board, regardless of whether banks appeared individually resilient or not. 3. Concentration The banking systems of the euro area have relatively high, and rising, levels of concentration.10 In the medium term further impetus in this direction could stem from market pressures and from Banking Union. So far the debate on macroprudential policy has ignored the question of how the structure of the banking system itself might affect an MAP regime. Yet there are at least three reasons why structure – in particular high concentration – should matter. First, the literature on the bank lending channel11 and the bank capital channel12 suggests that large banks with highly liquid and diversified assets are less sensitive to MP impulses (they adjust their credit supply more gradually to changes in the MP stance). A high level of concentration, with credit markets dominated by a few large players, would thus make it harder for MP to affect banking credit cycles: if the credit multiplier associated with monetary Visco (2009). As Stein (2014) notes, this activist approach is justified even if the monetary authority does not have an explicit financial stability objective. The point of tackling the underlying financial imbalance is to reduce the variance of inflation and unemployment around their target values. Brunnermeier et al. (2009). Acharya and Yorulmazer (2013), which builds on Rajan (1994), strategic complementarities cause herding in banks’ investment strategies: banks choose to take on correlated exposures because, if they do, negative shocks are more likely to cause systemic crises where institution-specific (e.g. reputational) losses are negligible and public bail-outs very likely. One could think of similar complementarities on the liability side of the balance sheet. See Catte, Pagano and Visco (2010) on the role of MAP in the US, i.e. whether adopting it would have prevented the bubble; see also Neri (2012). Between 2005 and 2011, the market share of the three largest banks in the European Union increased from roughly 46% to over 60%; in the US, it went from 20% to 30%, while in Japan it remained stable at about 40% (Bijlsma and Zwart, 2013). Kashyap and Stein (2000). Van den Heuvel (2001); Gambacorta and Mistrulli (2004). BIS central bankers’ speeches policy is low, any attempt to control credit aggregates through MP interventions would require large swings in interest rates, which in turn could cause significant distortions in relative prices outside the financial sector. While the effectiveness of MAP tools is still largely untested, a euro-area-wide MAP framework might well fill an important gap in this respect. Indeed, big, liquid, diversified banks may respond more to MAP impulses, as we know that right up until the onset of the crisis the capital ratios of large banks were very close to the regulatory minima. If this regularity were to be confirmed in the future despite regulatory changes, then we could conclude that large banks, with their thin capital buffers, are likely to be more sensitive to a countercyclical capital buffer (CCB) tightening. A second, related point is that the interaction between MP and MAP ought to be weaker and thus less problematic when the market is more concentrated. One important finding of the literature on the interaction between MP and MAP is that there can be significant overlaps between them.13 However, insofar as concentration weakens the financial stability spillover of MP by making banks’ lending decisions less dependent on the monetary policy stance, it also widens the scope for independent macroprudential decision-making.14 This would be good news for the euro area, where the policy framework should place national MAP authorities in a good position to internalise conflicts between MAP and MP. Finally, the concentration of the industry is also an important determinant of the extent of any overlaps, hence potential tensions, between MAP and MIP. To see why concentration matters in this context, think of two polar cases. In a one-bank economy, the overlap between MIP and MAP is perfect, and coordination is crucial. If there is no coordination, in a recession the MIP authority raises its requirement, the MAP authority reduces its own, and they end up neutralising one another. In an economy with many (N) small banks, on the other hand, the overlap must be less significant. As long as the banks’ levels of capitalisation differ, the MAP authority can lower the requirement on all banks while the MIP authority can pursue its objective of preventing idiosyncratic bank failures by raising capital requirements for the k banks it identifies as fragile. In net terms, capital requirements will be effectively reduced only for N-k banks. This means that MAP is again diluted by MIP, but the dilution is targeted to the banks that need higher ratios in relation to their risk. Furthermore, the combined intervention stimulates a reallocation of credit from fragile to sound banks, which is of course a desirable outcome.15 MIP and MAP are clearly complementary from the operational standpoint. The synergy works in two ways: MAP analysis should inform and help focus the activity of micro supervisors; at the same time, micro supervisors will have a key role to play in implementing most macro policy interventions, because these are largely based on the use of micro tools to pursue macro objectives.16 However, the two policies have different aims, and the example above suggests that the tension between them may be more severe in concentrated banking systems. Compared with other systems, EA economies are in many ways closer to the polar one-bank case. This means that it is crucial to work out an explicit ranking of the policy objectives. As a consequence, clearly defining the processes that regulate the interaction between MIP and MAP authorities will be particularly important for the EA. To my mind it is clear that the Angelini, Nicoletti-Altimari and Visco (2013); Angelini, Neri, Panetta (2014); Collard et al. (2013). Of course, there are other channels through which MP can affect financial stability, such as via risk taking (e.g. Borio and Zhu, 2012). Heterogeneity among banks is crucial to this argument: if the N small banks all hold identical portfolios and capital buffers, then tension between MAP and MIP arises here exactly as in the one-bank world. This is another argument for preventing the sort of herd behaviour mentioned in Section 3, incentivising instead the diversification of business models and investment strategies between banks. Bank of England (2011). BIS central bankers’ speeches overarching MAP objective of reducing systemic risk logically precedes the MIP objective of preventing idiosyncratic bank failures, for three complementary reasons. First, no individual bank can be deemed sound where significant systemic risks loom large: as we learned in 2008–9, even liquid and well-capitalised banks can be quickly cornered if funding markets seize up or asset prices plummet owing to fire sales. Second, idiosyncratic bank failures are a matter of concern almost exclusively for systemic spillovers: a bank’s failure may or may not constitute a serious problem, depending on whether its counterparties can withstand its demise. Third, experience shows that big, well-diversified banks are largely sheltered from idiosyncratic shocks and can only become insolvent because of a systemic shock. On these premises, my view is that MIP should work to fine-tune regulatory requirements for individual institutions subject to the provision of adequate aggregate financial stability by MAP. The governance structure we set up in the euro area might strike external observers as overcomplicated. Yet its design is conceptually appealing, because it puts us in a good position to insure coordination between MIP and MAP at both European and national level. What is crucial is that the ECB retains both MIP responsibilities (through the Single Supervisory Mechanism) and, in coordination with the European Systemic Risk Board, direct MAP powers to adjust the policy stance of individual national authorities (through CRR/CRD IV). The Governing Council should thus be able to internalise any tensions between MIP and MAP and establish a well-defined hierarchy between them. 4. Caveats: getting MAP to work There are, of course, risks and uncertainties attached to the implementation of MAP in the euro area. A first challenge – and one that is clearly not confined to the euro area only – is that financial cycles, like most economic phenomena, are notoriously difficult to identify ex ante. Assessing in real time the causes behind any divergence among countries or markets, and establishing to what extent they reflect fundamentals, is not easy. One should guard against the temptation to look at a handful of indicators in isolation. MAP should ideally be grounded in the analysis of a broad set of risk indicators and rely on a joined up, holistic view of how these are related to economic fundamentals, domestically and abroad. Structural economic models can certainly help, but they are plainly not rich enough to capture all the dimensions of the problem. Hence, MAP policy-making is largely judgmental, and will remain so for some time to come. To operationalise MAP it is also crucial to identify how far banks (that is, leveraged financial intermediaries) are involved in any hypothetical build-up of risks. The amount of systemic risk generated by a bubble depends on a number of factors, including who is financing it and whether the funding comes in the form of equity or debt. Typically, it is the direct participation of banks in a bubbly market that can turn a local problem into a systemic event.17 Real-estate markets are an interesting example of this problem, so allow me to return briefly to the credit and house price data I used earlier. Preliminary statistical evidence suggests that in several EU countries bank lending predicts house prices (Table 1). This is consistent with credit being an important determinant of the demand for housing. An inverse causation, with higher prices driving more real-estate financing by banks, is potentially more problematic because it may signal that asset prices are distorting banks’ choices: prices might be growing for exogenous and possibly non-fundamental reasons (a “bubble” or a wave of optimism), and banks might be piling in to reap capital gains on the housing stock. In this case the probability of a sharp correction in prices is higher. Such a correction is also more likely to translate into a banking crisis unless macroprudential measures are appropriately tightened Aoke and Nikolov (2012); Reinhart and Rogoff (2008). BIS central bankers’ speeches beforehand. Interestingly, the only country for which house prices predict credit among those listed in Table 1 is Spain.18 Even when the diagnosis is reasonably clear (as was apparently the case for the Spanish mortgage market in the early 2000s), political economy may get in the way of MAP: in practice, it is difficult to “take the punch bowl away”. Furthermore, there is a risk that national authorities may design and manage national MAP regimes in a way which, although rational from a domestic perspective, could have undesired consequences. For example, national authorities may relax constraints on lending in order to stimulate the expansion of the domestic banking sector, with potential adverse spillovers for financial stability in other markets. The controls at the ESRB and SSM level mitigate the risk of these negative spillovers, but other risks are more subtle and harder to address. When faced with an increase in a specific sectoral risk, relating for instance to real-estate loans, a national MAP authority could force banks to hold more capital by a) raising the overall capital requirement, b) creating an ad hoc buffer on real-estate exposures (although presently this is not allowed under the CRDIV/CRR), or c) increasing the risk weights. These seemingly identical measures actually differ in important ways. One of them is the degree to which regulators wish to be transparent about what their concerns are: the nature of the vulnerability may not be fully disclosed in case a). Another is the impact on market perceptions: compared with their foreign peers, domestic banks would look relatively better capitalised in cases a) and b), while they would be perceived as relatively undercapitalised in c). The euro-area configuration, with the ECB-SSM in a position to top up national measures, goes in the direction of assuaging political economy concerns of this kind. The punch bowl may be taken away by someone other than the host, namely a supranational authority. Furthermore, the fact that all individual initiatives must pass the collective examination of the ESRB and/or the Governing Council limits the scope for strategic choices by individual countries. MAP is certainly going to be “an adventure more than a job”, and it will entail a lot of adaptation and learning by doing. Here practice must necessarily come before theory. But since MAP can play a crucial role in resolving current economic difficulties, and the euro area has a sound institutional framework in place to handle it, our practice should begin in earnest, and sooner rather than later. 5. What could MAP do today, and how? These reflections suggest that MAP could make a considerable difference in the euro area. It is likely to be a powerful instrument; it reintroduces a degree of flexibility that could compensate for the lack of national monetary policy frameworks; and it can relieve monetary policy of some of its burden. The question is how to relate this structural discourse to our current impasse. As we know, the euro area is not in good shape: inflation is too low, growth is weak, MP is stretched and affected by financial segmentation, banks’ balance sheets are still strained, credit is scarce. Credit growth is weak across the area, although the underlying causes might differ across countries, and the need to stimulate credit supply accordingly ranks high on policy-makers’ agenda.19 Thus, the dilemma faced by MAP today is how to improve the financing conditions without further undermining banks’ resilience. An alternative explanation for this predictive relation is that rising house prices relax households’ borrowing constraints, allowing them to take on more debt. The two hypotheses cannot be disentangled by looking at plain correlations. Miles and Pillonca (2008) suggest that expectations of capital gains played a significant role in driving housing credit in Spain, Sweden, Belgium and the UK before the crisis. Draghi (2014) clarifies that the ultimate objective of the comprehensive assessment is to address capital constraints on credit supply. BIS central bankers’ speeches How should this dilemma be resolved? The set of recent policy initiatives taken and discussed within the ESRB suggests that decision-makers have reached a consensus. In the Netherlands the central bank has announced the introduction of a systemic risk buffer for banks starting in January 2016, and similar initiatives have been taken in Belgium, Croatia and Estonia.20 The core of the consensus thus appears to be (a) that the key MAP instruments in these circumstances are bank capital ratios and (b) that a conservative policy stance is called for. In short, all we need is “more bank capital”. This consensus has emerged without an explicit debate on the underlying policy trade-offs, and it has implicitly reduced the broad question of “what MAP should do” to a narrow debate on “whether capital requirements should go up or down”. This state of affairs is dangerous and potentially harmful, regardless of one’s conclusions on the pros and cons of raising capital requirements. This for three reasons. First, we are not paying enough attention to the relation between MAP and MIP. I argued earlier (i) that the interplay between the two is delicate, (ii) that coordination is important, particularly in the euro area, and (iii) that MAP should take priority over MIP when their objectives appear to clash. From this point of view, our conduct seems an example of how not to run MAP. Interactions and coordination have indeed been largely absent from the policy discussion. For example, given the great heterogeneity in banks’ conditions, one could ask whether resilience could be improved by a set of selective MIP interventions on weak institutions, rather than a non-discriminatory increase in MAP capital requirements. This option, however, is not being discussed. We are glossing over the issue of coordination between MAP and MIP. The absence of discussion is bad per se, and it also carries a subtler but equally negative implication: the observed alignment between MAP and MIP authorities (both of which push for banks to hold more capital) could be interpreted as a sign that we are simply placing MIP objectives above MAP. As I remarked above, I consider this approach to be deeply problematic. The second pitfall is that we seem to have accepted that bank capital ratios are practically the only weapon in the MAP toolbox. A behavioural economist would view this focus on capital as an example of ambiguity aversion. That is, we might be acting mainly through capital ratios for the same reason stock market investors over-buy domestic stocks – simply because we know them better.21 Like a home bias in investment, such a “capital bias” can obviously be suboptimal: we could gain by greater “diversification” of our intervention “portfolio”. Furthermore, if we determine that tighter capital requirements are necessary but believe they have a negative spillover effect on credit supply, we should combine the tightening with initiatives to mitigate pro-cyclicality. A useful analogy can be drawn with MP, where interventions aimed at controlling the exchange rate can be sterilized in order not to affect the domestic money supply. In our case, we should be looking for ways to sterilize the impact of stiffer requirements on aggregate credit and economic activity. Admittedly, this is not easy, but it is possible. For example, it could be done by incentivising banks to build up their capital ratios through cost rather than credit cuts (I will shortly provide an example of this, based on our recent experience at the Bank of Italy). It could also be done by facilitating firms’ recourse to non-bank intermediaries (such as insurance companies) or by stimulating bond and stock issuance, in particular by SMEs.22 Slovenia is moving in the opposite direction, and at the end of June will introduce a minimum loan-to-deposit ratio, in order to slow banks’ deleveraging. Following the ambiguity aversion analogy, the bias may stem because we are able to characterise, in probabilistic terms, the implications of a shift in bank capital requirements, which have a long history of regulation, while we lack this ability for other, new or relatively untested MAP policy instruments (see e.g. Barberis and Thaler, 2003). The Italian insurance supervisor (IVASS, which is under the control of the Bank of Italy) has now broadened the possibility for insurance companies to buy corporate bonds. The Italian government is introducing tax BIS central bankers’ speeches The third problem is that the consensus does not seem to rest on a clear, shared understanding of the cause of the credit crunch. It should, because there is no ready-made, cookbook-style answer to the question of what MAP should do in a recession with weak credit (or in any other situation for that matter), as the policy measures to mitigate the crunch will differ with the causes. We should be wary of recipes that simply suggest more capital because “risk is high”, or less capital because “credit is weak”, without further analysis of the fundamental factors that drive the data. For example, if the credit crunch is caused by high credit risk, then higher capital requirements would certainly be the right choice. But if instead it depends on high funding costs for banks regardless of their individual situation (say, the poor condition of the domestic sovereign), raising capital charges might work (well-capitalised banks also obtain funds at lower rates) but it would clearly be second-best (central banks have a range of alternative tools that affect banks’ funding more directly). Finally, consider a crunch caused by a problem of coordination among banks. When an economy with a concentrated banking system is at a turning point, large lenders certainly have a notion that the speed of the recovery depends on their lending strategies, and they might well realise that lending more, or on softer terms, is the optimal strategy because it would stimulate growth and generate higher returns. Even in that case, however, it could well be that nobody is willing to bear the risk of expanding their balance sheet unless everybody else does likewise. The reason is that without coordination the recovery will not start and the lender who took the solitary initiative will pay all the costs of running a large balance sheet in a still recessionary environment: a credit crunch could emerge as a suboptimal Nash equilibrium. In this case, MAP policy could facilitate coordination among lenders to bring the crunch to an end and make the banking sector sounder.23 These stories are all possible and credible. Any policy prescription should be based on a discussion of which of them we believe to be most plausible. It seems to me that so far this discussion – like those on MAP-MIP interactions and MAP tools mentioned above – has been largely bypassed. The current conjuncture obviously puts pressure on policy makers to act decisively and narrows the room for wide-ranging discussion of governance and general principles. The MAP mechanism is now operating in conditions that are very different, and probably more complex, than those that will prevail in the future: in the pre-crisis period banks did not build up sufficient macroprudential capital buffers, greatly complicating the policy dilemma. After all, increasing prudential capital requirements might well be the right policy choice given the uncertain prospects of our economies. My main contention is that, even if that is so, we cannot afford to restrict ourselves to this strategy, or stick to it in a way that the public may see as a-critical. The decisions we take today set an important precedent for how MAP will work and how it will be expected to work in the future. Accordingly, I submit that being transparent on the logic behind MAP initiatives and making sure that that logic is consistent with our agreed principles, is at least as important as getting the details of any specific intervention right. The costs of setting a bad precedent or weakening the credibility of MAP, and particularly of its countercyclical nature, are hardly quantifiable, but I suspect that they would be very high indeed. The only way to contain them is to make sure that our decisions – whatever they are – derive from first principles, rest on sound economic analysis, and represent the outcome of a transparent, open dialogue among the authorities. benefits for IPOs and new equity issuance, as well as non-pecuniary incentives to stimulate issuance of bonds and equities by non-financial companies. A similar story is formalised by Bebchuk and Goldstein (2011). Note that in this case MAP can have a role to play ex post, after the burst of a credit bubble, for exactly the same reason why it has one ex ante, in the buildup phase: it corrects externalities (a strategic complementarity) that could otherwise bring about suboptimal equilibria. BIS central bankers’ speeches 6. From theory to practice Speculating on the interactions between MP, MAP and MIP in abstract is one thing. Bridging the gap between theory and practice, and setting up mechanisms that run reasonably smoothly, is another. Like many other central banks in the euro area (and beyond), the Bank of Italy has a micro (MIP) supervisory function that coexists with its macro (MP) function.24 This coexistence requires two elements. The first one is a protocol that regulates the bottomup flow of information and allows the Board to form a consistent view of the state of affairs and of the related risks. The second one is a mechanism that defines the top-down transmission of decisions, assigning clear responsibilities to all the sub-structures involved in implementing any policy interventions agreed by the Board. Seen through a financial stability-MAP lens, the information flow within the Bank of Italy can be divided into three phases. First, risks are examined separately by the areas with the relevant expertise. Micro risks relating to banks’ balance sheets are examined by the supervisory directorates; risks relating to money markets are monitored by the markets and payment systems directorate; macro conditions of any other kind are looked at by the economics and statistics directorate. This information is shared and debated within the Financial Stability Coordination Committee. Meetings are ordinarily held twice a year, but can be called at any time by the committee members – the heads of the key directorates – or by its chair – a deputy governor. The third and last phase involves a discussion with the Board on the key conclusions, which includes a critical assessment of the evidence, a ranking of the risks and, if necessary, a list of suggestions for potential policy actions. A supervisory initiative launched by the Bank of Italy in 2012 provides an example of the workings of this mechanism. In that case, a prolonged fall in non-performing loan coverage ratios (a micro signal) was deemed to be a potential threat for market confidence, particularly in a recessionary scenario (a macro issue). The Bank therefore launched a targeted but broad on-site review of positions with low coverage ratios to ensure that accounting practices were correct.25 In order to avoid pro-cyclical effects, in parallel with this wave of inspections the Bank of Italy asked banks to increase internally-generated resources by cutting costs, selling non-strategic assets, adopting sustainable dividend policies, and revising the criteria for the remuneration of directors and executives. These actions, the results of which have been published, have improved banks’ practices and standards; they have helped to reverse the declining trend in coverage ratios, increase transparency and assuage investors’ concerns. Thus, they relied on micro tools but were macro in spirit. These processes will have to be adapted in the light of the radical institutional changes being introduced both at the national level (establishing a new MAP authority) and at the international level (MIP and MAP coordination and burden-sharing between national authorities and ESRB, EBA, SSM). Often, the devil is in the detail, and admittedly many details need to be sorted out for this architecture to work well. Therefore, it would be sensible to divide our time between speculation on the conceptual challenges posed by the interaction between MP, MAP and MIP and a less exciting but equally crucial effort to create a sound and effective governance structure. 7. Conclusions Bold policy initiatives are rarely preceded by long periods of careful reflection. On the contrary, they are often taken in response to dramatic and unforeseen changes in the The law that introduced capital requirements and assigned the Bank of Italy supervisory powers dates back to 1926 (see https://www.bancaditalia.it/bancaditalia/storia/1936/il_dopoguerra ). It was judged necessary to preserve a satisfactory level of provisioning in order to maintain investor confidence and low funding costs, particularly given the market tensions stemming from Italy’s fiscal imbalances. (Panetta, 2013a). BIS central bankers’ speeches economic environment and (or hence) often at times when little is known about what the future holds in store. The situation we find ourselves in today is no exception to this rule. The financial turmoil created a strong rationale to introduce MAP, but our knowledge of the potential of this new tool is less than perfect. It will take a while to acquire that knowledge, to understand how MAP interacts with MP and MIP, and to explore ways to get the best out of all three. Operating the system in the meantime will surely be challenging. The spirit of my remarks today is that, besides being inevitable, this challenge is very much worth meeting. MAP can deliver great benefits to the euro area in terms of macroeconomic and financial stability. Furthermore, the area has an institutional framework that favours coordination and places us in a good position to observe and exploit the complementarities between this and other, more traditional policy frameworks. We knew from the start that learning by doing would be central to MAP. Given these two preconditions, we should start doing, and learning, as soon as possible. References Angelini, P., Neri, S., and Panetta, F., 2014, “The Interaction between Countercyclical Capital Requirements and Monetary Policy”, Journal of Money, Credit and Banking, forthcoming. Angelini, P., Nicoletti-Altimari, S., and Visco, I., 2013, “Macroprudential, Microprudential and Monetary Policies: Conflicts, Complementarities and Trade-offs”, in Dombret, A., Lucius, O. (eds.), Stability of the Financial System – Illusion or Feasible Concept?, Elgar Edwards Publishing. Aoke, K., and Nikolov, K., 2012, “Bubbles , Banks and Financial Stability”, ECB Working Paper, 1495, November. Banca d’Italia, 2014, Financial Stability Report, No.7, May. Bank of England, 2011, “Instruments of Macroprudential Policy”, Discussion Paper, December. Barberis N., and Thaler R., 2003, A survey of behavioural finance, in Constantinides, Harris and Stulz eds. Handbook of the Economics of Finance, Elsevier. Bebchuk L.A., and Goldstein, I., 2011, “Self-Fulfilling Market Freezes”, The Review of Financial Studies, 24(11), 3519–3555. Bijlsma J.M., and Zwart G.T.J, 2013, “The Changing Landscape of Financial Markets in Europe, the United States and Japan”, Bruegel Working Paper, 2013/02, March. Bologna, P., and Caccavaio, M., 2014, “Euro Area (Cross-border?) Banking: Before and After the Global Financial Crisis”, manuscript. Brzoza-Brzezina, M., Kolasa, M., and Makarski, K., 2013, “Macroprudential Policy Instruments and Economic Imbalances in the Euro Area”, ECB Working Paper, 1589, September. Brunnermeier M.K., Crockett A., Goodhart C.A., Persaud A., and Shin H.S., 2009, “The Fundamental Principles of Financial Regulation”, Geneva Report on the World Economy, 11, July. Caruana J., 2011, “Monetary Policy in a World with Macroprudential Policy”, speech delivered at the SAARCFINANCE Governors’ Symposium, Kerala, June. Catte, P., Cova, P., Pagano, P., and Visco, I., 2010, “The Role of Macroeconomic Policies in the Global Crisis”, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), 69, July. Claessens, S., and Van Horen, N., 2013, “Foreign Banks: Trends and Impact”, Journal of Money Credit and Banking, 46(1), 295–326. BIS central bankers’ speeches Collard, F., Dellas, H., Diba, B. and Loisel, O., 2012, “Optimal Monetary and Prudential Policies”, Banque de France, Document de Travail, 413, December. Draghi, M., 2014, “Monetary Policy in a Period of Prolonged Inflation”, speech delivered at the ECB Forum on Central Banking, Sintra, May. Gambacorta, L., and Mistrulli, P.E., 2004, “Does Bank Capital Affect Lending Behavior?”, Journal of Financial Intermediation, 13(4), 436–457. Haldane, A.G., 2013, “Macroprudential Policies – When and How to Use Them”, paper presented at the International Monetary Fund conference on Rethinking macro policy II: first steps and early lessons, Washington DC, April. Kashyap, A.K, and Stein, J.C, 2000, “What Do a Million Observations on Banks Say about the Transmission of Monetary Policy?”, The American Economic Review, 90(3), 407–428. Ministero dell’Economia e delle Finanze, 2014, Chiarimenti in tema di Aiuto alla Crescita Economica (ACE), Circolare 12/E, 23 maggio. Miles, D., and Pillonca, V., 2008, “Financial Innovation and European Housing and Mortgage Markets”, Oxford Review of Economic Policy, 24/1, 2008, 145–175. Neri, S., 2012, “Financial Intermediation and the Real Economy: Implications for Monetary and Macroprudential Policies”, in Gerlach, S., Gnan, E., and Ulbrich, J. (eds), The ESRB at 1, SUERF Studies: 2012/4. Panetta F., 2013, “Banks, Finance, Growth”, remarks delivered at the Associazione per lo Sviluppo degli Studi di Banca e Borsa, March. Panetta F., 2013b, “Macroprudential Tools: Where Do We Stand?”, speech delivered at the Banque Centrale du Luxembourg, May. Reinhart, C., and Rogoff, K., 2008, This Time Is Different: Eight Centuries of Financial Folly, Princeton University Press. Stein, J.C., 2014, “Incorporating Financial Stability Considerations into a Monetary Policy Framework”, remarks delivered at the International Research Forum on Monetary Policy, Washington DC, March 21. Van den Heuvel, S. J., 2001, “The Bank Capital Channel of Monetary Policy”, manuscript. Visco I., 2009, “The Financial Crisis and Economists’ Forecasts”, commencement speech to the students of the Faculty of Economics, La Sapienza University, Rome, March. BIS central bankers’ speeches Table 1. Test of Granger causality between lending for house purchase and housing prices in selected EU countries (2003Q2-2013Q3, annual growth rates) Country Belgium France Italy Netherlands Spain UK Germany F-Statistic 5.071 4.928 4.638 2.866 4.030 4.583 Prob. 0.006 0.006 0.016 0.099 0.027 0.009 Significance level Causality (2) 2007 LTV ratio *** C→P *** C→P ** C→P * C→P ** P→C *** C→P Not significant Banking Real-estate crisis crisis x x x x x x x (1) The null hypothesis is no Granger causality. Lending for house purchase is measured as domestic credit to households for house purchase as a share of GDP. (2) C→P = credit causes house prices; P→C= house prices cause credit. BIS central bankers’ speeches Figure 1: Heterogeneity across Europe (A) Bank loans to firms in selected euroarea countries (per cent of GDP) (B) Domestic bank lending to the household sector (per cent of GDP) Germany Spain France Italy Source: ECB and Eurostat (C) House prices in selected European countries '00 '01 '02 France '03 '04 '05 '06 '07 '08 United Kingdom Italy Euro area Germany Ireland '09 '10 Spain '11 '12 Netherlands Source: Bank of Italy, Financial Stability Report. BIS central bankers’ speeches | bank of italy | 2,014 | 6 |
Opening remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Eurofi Financial Forum 2014, Milan, 11 September 2014. | Ignazio Visco: How to react to the fragmentation and the slowdown of the EU economy? Opening remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Eurofi Financial Forum 2014, Milan, 11 September 2014. * * * Ladies and Gentlemen, it is a pleasure to join Jacques de Larosière in welcoming you here in Milan. This event occurs at a crucial juncture for the European project and I hope it can be useful to shape our minds on what needs to be done. On my side, I will offer some thoughts on the current economic situation in the euro area and on the actions that are in my view most urgently needed. 1. Economic situation in the euro area and the monetary policy response Let me start by briefly recalling the latest macroeconomic developments. In the euro area recent data indicates that growth perspectives remain subdued and economic weakness is no longer confined to countries under stress. Amid ongoing geopolitical tensions, the stimulus provided by exports may be losing momentum, while domestic demand continues to drag because of the contraction in gross fixed capital formation. Confidence indicators worsened in recent months. Among firms, the deterioration is particularly pronounced in the manufacturing sector, owing to the heightened uncertainty on world trade. Households’ confidence is affected by the persistently weak conditions in labour markets, with too high rates of unemployment in the euro area at large. The overall outlook is still consistent with a moderate growth of economic activity in the second half of the year, but downside risks have clearly increased. Last week, the ECB revised downwards the projections of GDP growth for the next two years. Since Autumn 2013 inflation has been declining at a pace faster than expected, prompting continuous downward revisions of forecasts. In August the headline inflation rate was as low as 0.3 percent in the euro area and has turned negative in a number of countries. Declining inflation reflects not only the fall in energy prices, compounded by the past appreciation of the euro, but also the persistent weakness of the economy. Core components are in fact proving to be increasingly sensitive to the prolonged slackness in domestic demand. Medium-term inflation expectations have decreased markedly. At the end of August, based on inflation swaps, 1 and 2 year-ahead expected inflation rates were, respectively, at 0.8 and 1.1 percent; only at horizons as far as 2022 does expected inflation appear to be consistent with the ECB definition of price stability. With declining, even negative, inflation rates the consolidation of public and private debt is more difficult, while persisting nominal rigidities hamper the adjustment of relative prices. This difficult situation is aggravated by persistent divergences among countries. Fragmentation of financial markets along national lines in the euro area has progressively receded after the announcement of the OMT programme in the summer of 2012, but is still present. Firms’ and households’ borrowing costs in stressed countries are still higher than average, mainly reflecting the larger credit risk. For example, in July the cost of new bank loans for Italian non-financial corporations remained 60 basis points higher than the euro area average. The response of monetary policy has been wide-ranging. Last week the ECB’s Governing Council decided to further cut policy rates to new unprecedented levels, basically reaching the zero lower bound for the Main Refinancing Operations; it also launched two assetpurchase programs (entailing ABS and covered bonds), which together with the Targeted BIS central bankers’ speeches Longer-Term Refinancing Operations decided in June go clearly in the direction of fully restoring the monetary policy transmission mechanism and supporting the provision of credit to the broad economy. 2. Macro-prudential policy can support the monetary policy task Averting the risk that a too-prolonged period of low inflation would eventually lead to a disanchoring of medium-term inflation expectations is paramount. If needed, further monetary policy actions can be undertaken. Of course, we are well aware that, as the crisis has dramatically revealed, a prolonged period of low interest rates may fuel financial vulnerabilities and imbalances. In a monetary union with diversified financial conditions, tensions may emerge in some countries or in specific market segments or asset classes. However, compared to the past, in the present circumstances monetary policy has a powerful ally: macroprudential policy. In the European Union, with the new powers resulting from the entry into force of the CRDIV-CRR package, national authorities now have at their disposal an array of instruments to tackle localized emerging pressures. Indeed a number of countries have already started to act, in particular to address pressures in real estate markets. The new framework ensures also a Europe-wide leg for macroprudential policy, with a view of addressing potential negative spillovers of country-specific measures. The European Systemic Risk Board is tasked with monitoring and assessing systemic risks at EU level and represents the European forum where national authorities can discuss and coordinate their positions and policies. Moreover, the SSM Regulation has empowered the ECB with specific macroprudential tasks, such s the possibility to directly apply more stringent capital buffers to banks, as well as with a coordinating role within the euro area. Overall, there appear to be no constraints for monetary policy to continue providing the required stimulus to the euro area economy. At the same time, we know that the use of macroprudential tools as a leaning-against-the-wind response to the accumulation of financial risks depends on both the instruments used (e.g., countercyclical capital buffers, Loan-to-Value or Debt-to-Income ratios) and the targeted sector/asset class (e.g., real estate, corporate bonds).At any rate, even more than to counter the building-up of financial imbalances in the face of shocks, macro-prudential measures should be effectively used to increase the resilience of the financial system. 3. Financing investment and the recovery Following deep financial crises, economic recovery has always been slow to materialize. However, the disappointing economic performance in the European Union goes well beyond previous experiences. At the heart of the problem is the weakness of aggregate demand, in particular investment. Since the beginning of the global crisis, in the euro area public and above all private investments have collapsed, by 20 percent in real terms over 2007–13, more than in the European Union. In Italy the fall was even larger, by more than25and 30percent, respectively, for private and public investment. Reviving investment – public and private, national and European – is critical in order to jumpstart recovery. Several factors held back investment; among them: – widespread uncertainty about prospective demand growth; – deleveraging by over-indebted firms; – difficult access to credit. BIS central bankers’ speeches Today’s overarching goal is to make the business environment more conducive to investment. Besides the implementation of country-specific structural reforms, which is of critical importance, investment requires supportive financing conditions. The Italian Presidency has placed this theme at the top of its agenda. To foster investment and to improve access to credit, four priorities stand out: – reducing the cost of capital; – reviving securitization; – developing capital market sources of finance; – investing in infrastructure. Let me briefly discuss each of them in turn. Reducing the cost of capital The latest indicators of credit supply display some signals of improvement in lending conditions. The Eurosystem Bank lending survey shows that, in the second quarter of 2014, euro area banks, including Italian ones, reported a net easing of credit standards on loans to enterprises for the first time since the second quarter of 2007. Credit terms have been eased for households too, following a trend which started at the beginning of the year. While these signals are encouraging, there is still significant room for improvement as credit standards remain tight compared to the pre-crisis years, also in countries that did not experience any credit boom before the financial crisis. As mentioned, monetary policy is doing its part to reduce the cost of capital and secure more uniform credit conditions across the monetary union. An important contribution to sustain and accelerate the flow of credit to the economy will come from the TLTROs, as they contain specific built-in incentives for banks to on-lend to the private sector the funds obtained from the Eurosystem. Our own estimates for Italy show that if banks fully took up the additional funding and passed on the cost advantage to borrowers, the beneficial impact on GDP could reach 0.5 percent, a sizeable amount. The completion of Banking Union, including a smooth start of the Single Supervisory Mechanism and a swift implementation of the Single Resolution Mechanism, together with the continuation of an ordered process of balance sheet repair at European banks will help ensure the full functioning of credit markets. Beyond Banking Union, it remains critical to address country-specific macroeconomic risks and vulnerabilities, such as weak competitiveness and current account imbalances, as well as to ensure sustained progress towards sound and sustainable public finances. Reviving securitization Reviving securitization has been long recognized as an essential complementary instrument and several initiatives have been debated (also in a joint paper by the ECB and the Bank of England) to revive this market. In particular, it is necessary that simple and transparent securitizations be defined, and then promoted, in a consistent way across the EU. Furthermore, a set of common rules applicable throughout the financial sector should aim to avoid arbitrage opportunities across financial intermediaries and types of securities. Finally, more information on the characteristics of securitization and the underlying loans should be made available to investors. In order to achieve these objectives, there is now a need to agree on an EU-shared regulatory framework for high-quality securitization. BIS central bankers’ speeches Developing capital market sources of finance From a medium-term perspective, it will be important to develop capital market sources of finance in order to progressively make euro area firms less reliant on bank credit. This would also contribute to a rebalancing of firms’ financial structure after the fast increase in their leverage during most of the past decade in several euro countries. The Italian Presidency’s agenda emphasizes the development of capital market sources of finance and of non-bank financial intermediaries (venture capital funds, debt funds, European Long-Term Investment Funds – ELTIFs). In the face of the several valid proposals that have already been put forward, notably by the Commission, this agenda thus offers a good starting point towards selecting a well-defined set of priorities and moving to the implementation phase. A first important lever is to provide non-financial firms with incentives for more equity financing, which allows them to better undertake medium and long term investments, including those in research and development (best financed by risk capital), while decreasing their financial vulnerability. Taxation may play a key role in providing these incentives. For example, the use of an allowance for corporate equity (ACE), which allows corporations to deduct a notional return to new shareholders’ equity, reduces the tax advantage of debt funding while generally implying, due to its incremental nature, only a limited loss in tax revenues (an ACE was introduced in Italy in 2011 and reinforced in 2013 and 2014.) Increasing non-bank sources of finance for the economy, and specifically for SMEs, also requires the development of financial intermediaries such as equity and debt funds, closedend funds that invest in loans, bonds and shares issued by unlisted companies. This semester could see the final approval of the Regulation on European Long-Term Investment Funds, a major step to stimulate their activity across Europe. Investing in infrastructures Along with country-specific structural reforms on the supply side, broader economic policy action is required to accelerate the building-up of infrastructure, both tangible and intangible, indispensable to the success of a true Single Market. The financing of infrastructures and the proposal for an EU plan of public investment require a more efficient use of public resources along with greater involvement of private funds. To this end, euro project bonds, public-private partnerships, infrastructural funds and public guarantees could be the instruments to lever on private investments. Strengthening the role of European Union’s financing institutions (EIB, EIF) and improving the coordination among national investment banks should be essential parts of the process to ensure the development of efficient and well-functioning infrastructure networks, which represent the backbone of prospering economies. 4. European integration as the ultimate way out of the crisis To conclude, let me reiterate that a substantial strengthening of the EU recovery, one that would go a long way towards the definite exit from the crisis, cannot be achieved by the isolated actions of individual economic policy authorities. In particular, monetary policy alone cannot revive growth and guarantee financial stability in the euro area if the problems underlying the crisis are not resolved at both national and European levels. The return to sustained and balanced growth requires broader economic policy action centered on investment – as I said, private and public, national and European – which is the linkage between today’s demand and tomorrow’s supply. The favorable financial conditions that both monetary policy and Banking Union are ushering in must not be missed. From a longer-term perspective, we need to resume the process of European integration, while recognizing that it is a long and arduous one, and far from being linear. The debate on BIS central bankers’ speeches the euro area’s “fiscal capacity” needs to be restarted. Beyond the important achievement of the Banking Union, it is essential to continue resolutely along the path to a fuller Union. Let me conclude by emphasizing once again that the benefits of strengthening European integration far outweigh the alleged advantages of weakening it. Choices must be made responsibly. The risks of inertia far outweigh those of action. BIS central bankers’ speeches | bank of italy | 2,014 | 9 |
Speech by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy, at Banca Popolare di Sondrio, Sondrio, 12 September 2014. | Salvatore Rossi: Finance for growth Speech by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy, at Banca Popolare di Sondrio, Sondrio, 12 September 2014. * * * Growth Italy has long strayed from the path of economic growth. Common sense tells us this is so and the data confirm it. In the last six years the recession has doubled the rate of unemployment and eroded 11 percentage points from per capita GDP. But our problems go back much further than that: in 2008, on the eve of the financial crisis, the average amount of goods and services produced by Italian workers was basically unchanged from 1995. In the same period other countries, spurred by the technological paradigm shift of ICT, had seen their productivity rates soar. The strong growth in employment that was nevertheless recorded in Italy in the pre-crisis years, favoured by the introduction of more flexible work contracts, proved insufficient to offset the effect of the stagnation of productivity on households’ disposable income. At the outbreak of the crisis, for the average household this was at the same level as in the mid1990s and only the progressive reduction of the saving rate had enabled modest growth in consumption. The diminishing ability to generate income heralds a decline in living standards, both with respect to this country’s past and to the world’s main players. This is all the more worrying when one considers that in forty years’ time the ratio of people of working age (20–69) to elderly retirees will have halved, from 4 to 2. Even just to maintain per capita living standards at their current levels would require an increase in labour productivity of 25 per cent. More jobs, more output: but how to achieve both together? Certainly, the recession has been keeping Italian consumers and investors in a state of suspension for too long now, more because of uncertainty and poor confidence than a lack of income. Stimulus must therefore come from macroeconomic policy. At European level, monetary policy is already acting as a spur and is stepping up its action. 1 At national level, fiscal policy can only change the mix: fewer taxes, less unproductive expenditure. Most of the government’s efforts should go to tackling the long-standing failings of our society, those that condition Italy’s entrepreneurial spirit. Jobs and productivity are only formed within businesses. The State cannot create them directly and would not know how to. The rules of good business have been neglected in Italy for almost half a century: by many entrepreneurs reluctant to expand their firms, and by public and political opinion prone to defending small and large rents. A good business is one that researches and develops new products and new methods, and pursues new markets. In the globalized economy, dominated by technologies that convey information and alter consumer tastes at the speed of light, the small, mature firm that is typically Italian does not have a very bright future; sometimes it does not even have a present. Of the main European countries, Italy is the one with the widest productivity gap between small and medium- large businesses. 2 Businesses start out small everywhere, but ECB (2014). Based on data provided by the Structural Business Statistics of Eurostat, in 2010 added value per employee in Italian firms with more than 250 workers was approximately three times that of firms with fewer than 10 workers; in equivalent firms in Spain it was double that of firms with fewer than 10 workers, in Germany one and a half times, and in France more than one fourth greater. BIS central bankers’ speeches then they either die or grow rapidly. In Italy, if they do not die, they remain in the small-size limbo for a long time: the proportion of small, mature firms (those in operation for at least ten years) is over 50 per cent here, compared with 45 per cent in Spain and 40 per cent in the United States and France. 3 Encouraging new start-ups, convincing existing entrepreneurs to expand their firms by separating them from the founding family’s fortunes, rewarding courage and inventiveness, and discouraging rents: these are the priorities of economic policy in Italy today. Reforming the bloated fiscal and legislative systems and unravelling the tangle of red tape that litters the path of entrepreneurs would enable Italy to move up several places in the global Doing Business rankings and spark a virtuous circle between favourable expectations that then become self-fulfilling; it would free the energies that this country still has in abundance. Finance 4 In the meantime, however, the recession is burning up resources and hopes. In the political debate reported in Italy’s daily press, the hunt is on for the culprits of the failed economic recovery of these months. Banks are a recurring target, accused by some of denying credit to firms and households, thereby impeding the country’s exit from the crisis. But for such an accusation to make sense, first the fact has to be established and then, to use the legal terms, it must be proved that there was negligence or malice aforethought, in other words that banks – currently lumped together in a general category – are refusing to lend to the economy either because they would rather use the money available for unspecified financial adventures (malice) or out of incompetence or laziness (negligence). Let’s look at the facts by taking two snapshots of the situation of bank lending, one at the end of June 2008, immediately before the financial crisis erupted fully, and the other at the end of June 2014. In this period total outstanding bank loans to Italian firms declined from €860 billion to €830 billion, a lower level certainly, but not by much. In the initial phase of the crisis, however, credit had risen to over €910 billion in December 2011, so the reduction with respect to the peak was €80 billion. As a share of GDP (53 per cent), though, bank lending today is still higher than, say, in Germany and France. Lending to households, instead, expanded in the six years, from €520 to €600 billion. In the meantime, wholesale funding, primarily by foreign banks and large international investors, fell dramatically, from almost €800 to €550 billion, mainly owing in the last three years to the loss of confidence in Italy following the global markets’ reassessment of our sovereign debt. Banks have managed to combat the drying up of foreign funding by increasing domestic retail funding and above all by participating in the long-term refinancing operations of the European Central Bank. Without these, the credit squeeze would have been much more severe. This was not the main cause of the deterioration, however. Due to the persistence of the recession between 2008 and 2013 the total stock of non-performing loans to firms and households increased by just over €100 billion to €320 billion or by 16 per cent of total outstanding loans. As far as it is possible to understand from a comparison of data that reflect very different national definitions, this is higher than the average level in Europe. The outcome, partly owing to increased reserve requirements, has been a dramatic fall in bank profits, while the riskiness of firms’ new credit demand has increased sharply. Criscuolo, Gal and Menon (2014). This section reprises and develops a line of thinking elaborated on in recent months by Visco (2013, 2014), Rossi (2013), and Panetta (2014). BIS central bankers’ speeches Furthermore, in recent years the banks have had to strengthen their capital bases. They were prompted to do so even more than by regulations and supervisors 5 by the recession itself (in that capital must be proportional to the riskiness of assets) and by the markets, where confidence in the banks most exposed to more risky sovereigns was faltering. Over the six years Italian banks expanded their core tier one capital by €50 billion, from €134 billion to €184 billion. This capitalization drive was sustained by raising equity on the market while at the same time retaining earnings – an arduous combination, as potential subscribers of the capital increases had to be offered the prospect of good future returns. The banks’ shareholders were called on to bear the brunt of the problems of debtor firms, with loan write-downs totalling nearly €140 billion. From the banks’ standpoint, the situation can be summarized as follows: before the crisis bank credit was abundant because funding on the wholesale markets (mostly abroad) was easy and because given low borrower risk no massive loan loss provisions were required. With crisis and recession, both of these conditions vanished, so the rational course for a bank, in the interest first and foremost of the savers who entrust their resources for prudent investment, is to slow or reduce lending to the firms perceived as riskier and step up investment in other, less risky and more profitable assets, such as government securities. Banks’ deleveraging was intensified by the sharp decline in credit demand from the less risky firms, many of which cut back or suspended planned investments. This straightforward analysis excludes the highly imaginative theory of “malice aforethought”. Let us now consider a second hypothesis, namely “negligence”, i.e. the banks’ culpable incapacity for sagacious, farsighted assessment of individual borrowers’ creditworthiness. Here, judgment must be more nuanced. The heterogeneity of behaviour among banks makes generic, summary judgment inadvisable. If we nevertheless intend to consider the system as a whole, it would seem to me that Italy is in the grip of a perverse interaction between the structural characteristics of the corporate system and those of the financial system. In too many cases Italian firms are not only small but financially fragile and bank- dependent. Their financial leverage rose prior to the crisis and is now high by international standards (44 per cent). Two thirds of their debt is bank debt. These features are more pronounced among the smaller firms, precisely those most severely affected by the tightening credit supply. For that matter, the typical features of Italian small businesses – diminutive size, little commitment of shareholder capital, lack of transparency – make it nearly impracticable for them to access the bond and equity markets directly, even if they wanted to (which they rarely do). For its part, the Italian financial system is notoriously bank-centred. At the end of last year bank loans accounted for 40 per cent of the total financial liabilities of households and firms (financial debt plus corporate equity), compared with 15 per cent in the United States, 23 per cent in France, and 30 per cent in the United Kingdom. Only Germany, another “bankcentred” economy, had a share comparable to Italy’s. Equity investment by venture capital and private equity funds, which specialize in start-ups and stimulating the growth of small businesses, amounts to 0.2 per cent of GDP in Italy, as in Germany, or half as much as in France and a fifth as much as in Britain. For many years the Italian banking system favoured the family-based, fragmented structure of its business customers because this gave them positional rents, sheltering them from competition from other sources of funds, namely the financial and equity markets. Now the banking system has become polarized: on the one hand, major players that tend to Many European banks brought forward their adjustment to the new Basel 3 regulatory framework and then readied themselves for the comprehensive assessment exercise under the Eurosystem’s Single Supervisory Mechanism. BIS central bankers’ speeches concentrate on the largest customers, using quantitative risk measurement methods; and on the other, a vast array of smaller banks, serving mainly small customers whose accounts are often inadequate and opaque, and accordingly require direct knowledge of the business. Such knowledge can be gained in two ways – by personal relationships or by analytical tools for assessing the firm’s technology and market characteristics. Both are useful, but each has a specific drawback. Personal relationships are more approximate and riskier, analytical tools costlier; in particular, as the latter have variable as well as overhead costs, they may be prohibitive where the business and the loan are very small. Add the consideration that in the event of default the inefficiency of Italian civil justice sometimes makes it uneconomic even to initiate a credit recovery action, so that banks will write off virtually the entire amount of a small non-performing loan, even if the expected loss, measured objectively, is limited. This practice impacts on banks’ lending decisions and the interest rates they charge. This situation would appear to constitute a “market failure”. The private sector parties, borrowers and lenders, are incapable of making the credit mechanism work efficiently because each responds to incentives and disincentives that clash with the general interest. Small businesses want to stay as “opaque” as possible; indeed, they are accustomed to understating their actual earnings for tax reasons. And in some instances banks do not procure adequate facilities or methods for evaluating firms, it being more convenient, and in the short run less costly, to rely on personal relationships. The outcome is adverse selection and credit rationing. 6 In some of the most pathological cases there have been outright bank failures. In short, if the hypothesis of “negligence” is well founded, it applies to both sides of the credit market. This vicious circle, in which ultimately everyone loses and nobody gains, must be broken. It is a life-or-death question for the many Italian SMEs that, while severely strained by recession, still retain their markets, innovative capacity and technological assets, and have the potential to recover. Half of our GDP is produced by small to medium-sized firms with fewer than 250 employees. These SMEs must be helped to grow, not left to die when they are not in fact terminally ill. First of all, they should be enabled to get off the IV support of bank credit alone and learn to raise funds in the market as well. This will take time. In the short term no more than a fraction of bank credit can be readily replaced. So this market failure must be remedied, to the benefit of all, by public intervention. But what form should that intervention take? In any case, public intervention must be respectful of the market and compatible with the budget constraints. The main tools available are government guarantees 7 and securitization. A very substantial contribution could also come from legislative and regulatory intervention to shorten credit recovery time by making bankruptcy procedures simpler and more efficient, and the securities collateral system more flexible. 8 Public guarantees offset the information shortfall between lenders and SMEs without taking the former’s place in assessing creditworthiness and without being a burden on the budget in the immediate, but only after bankruptcy is announced and within the limit of the ratio of insolvencies to the total guarantees granted. A good example is already provided by the Central Guarantee Fund operating under the aegis of the Ministry for Economic Development, which partially guarantees banks that grant loans to small firms and participates in the latter’s screening. Since 2009 the Fund has granted guarantees on loans amounting to more than €40 billion. The scale of the Fund’s operations could be further increased. See, among others, Panetta (2014) and the classic Stiglitz and Weiss (1981) cited therein. Agenda possibile (2013), Panetta (2014). Haselmann, Pistor and Vig (2010). BIS central bankers’ speeches Securitizations serve essentially to distribute the risk inherent in bank loans to SMEs among a large number of bank and non-bank institutional investors. In view of the small size of the loans, it is necessary to create asset-backed securities, i.e. packages of loans in the form of bonds, of which it is not too difficult to assess the quality, and place the various tranches with different investors according to their risk appetite. Operations can be carried out by the originator banks themselves or by other financial entities. These instruments could also be backed in part by public guarantees. Notable among the possible investors are insurance companies, which are often hard put in the present phase of the cycle to find desirable investments for their technical provisions in terms of risk/return and maturity. To develop such a market some regulatory problems must be overcome, firstly at international level. The global financial crisis has discredited instruments such as ABS, which were abused by pushing their complexity and opacity to the limit. But the abuses can be forbidden without eliminating the instrument itself, which retains its rational basis. The ECB has launched a very large programme for the purchase of simple and transparent ABS in order among other objectives to facilitate the financing of SMEs. The Bank of Italy and Ivass are following the matter closely. With great rapidity this summer Ivass drafted amendments to the regulations on insurance companies’ investments consistent with the new legislative provisions introduced recently to increase the competitiveness of the Italian economy. The new prudential regulations, aimed at achieving greater diversification of risk, will also allow insurance companies to grant credit directly subject to well-defined limits and conditions. The second public consultation, made necessary by the innovations introduced during the conversion of the competitiveness decree law, is drawing to a close; Ivass will shortly issue the new regulations. However, markets able to channel large volumes of financial resources from non-bank investors to SMEs cannot easily be created from one day to the next. Even when the regulatory questions have been settled, there will still be the problem of the information asymmetry between borrower firms and investors. Those who, better than others, know or understand the present and prospective conditions of firms, first and foremost the banks that originated the loans, therefore have an essential role to play. It must not be forgotten, however, that in Italy, as I mentioned earlier, the main problem regarding the functionality of the system lies in firms’ financial fragility. The most important task of public action is therefore to push firms towards equity financing rather than additional borrowing, using every possible means, regulatory and fiscal. But bank borrowing too can be made more rational by examining its technical forms. For example, traditional overdrafts are so widespread in Italy that they stand out by international standards. The fact that they do not establish a time limit for the credit actually granted creates problems for the calculation of interest and lessens their eligibility as collateral; in order to accept such loans as collateral, the Bank of Italy has recently asked for the inclusion of specific contractual clauses. Using finance to the advantage of growth The question of what are the determinants of economic growth in the long term has been at the centre of economic analysis since this came into being as a separate science. More than half a century ago attention was focused on productivity and technical progress as the decisive factors for growth, demoting the accumulation of physical capital, which had previously been considered the motor of capitalist growth. 9 Today a new conceptual leap is being attempted, moving up the scale of causes and effects; searching, in other words, for what determines productivity and technical progress, and finding it in the ability of a firm, an Schumpeter (1934), Solow (1956, 1957). There then followed numerous theoretical and empirical refinements of Solow’s model, such as Romer (1990), Grossman and Helpman (1991) and Aghion and Howitt (1992). BIS central bankers’ speeches economy, a society to “learn” continuously, 10 in dynamism, in endogenous inventiveness, in the taste for intellectual and entrepreneurial challenges. 11 Such ability may be found embedded in the culture and customs of a nation, as a result of a favourable historical confluence. Or it can be constructed, fed, by reasoned political action, as well as by entrepreneurs’ creative impulse. This is a complex task that involves all the different aspects of associative life, first and foremost the educational system; and not only this, but also the legal system, the condition of competition and the efficiency of the public administration. And finance? The financial system can be an engine of prosperity or a cause of backsliding. The history of economies, both old and new, has given us examples of one and the other situation. The whole world is still reeling from the destructive potential that finance revealed six years ago. It chooses how and where to distribute the resources: the incentives that orient these choices influence economic growth. 12 To be able to make these choices correctly, the financial system must “know” the corporate system. But what does financial system mean? For an Anglo-American it basically means markets, and the whole world of analysts, consultants, speculative investors and institutional investors that wheel about them. For a European, and even more for an Italian, it means banks. Markets and banks have different ways of knowing the firms that require finance. Markets can only gather and process data. Banks, in addition to data, can acquire direct knowledge of firms. A mass of studies and analyses in the last quarter of a century have argued that a broad and sophisticated financial system is essential for economic growth. It is a literature that is considerably influenced by the Anglo-American model, which sees markets as the heart of the system. After the “big chill” brought on by the global crisis, the basic assumption – the importance of finance for growth – has not been eroded, but there have been increasing qualifications and some rethinkings, for example on the recognition of an important role for intermediation, especially in getting credit to SMEs. 13 In Italy, as we have seen, the share of sources of funding other than bank credit is particularly small and should certainly be encouraged to grow. Our traditional banking activities can find new life, however, in a virtuous rediscovery of the mission to get to know firms, in particular the smallest ones. All the mechanisms for gathering and analysing data on firms need to be strengthened, including the ways in which that in formation is publicized and shared. Banks must increase their level of technical knowledge, including expertise in products, production methods, markets, about the firms applying for loans, particularly in this recession, when loan applications tend to be for generic purposes and less tied to investment plans, which are easier to evaluate objectively. 14 We are moving towards a different financial system from the one we are used to. Policies, laws and practices must be geared to allowing firms – especially innovative ones – to have more of their own capital, paid in by the owners or from specialized funds, but also raised on the capital market. 15 For this reason Italian SMEs must take a decisive step towards ensuring As Stiglitz and Greenwald say (2014), starting from Arrow’s lesson (1962), “learn to learn, learning”. Phelps (2013). Levine (2014). See, for example, Beck (2013) and CBI (2012). Bain & Company and IIF (2013). According to our calculations, today in Italy there are 500 enterprises that meet the criteria and would benefit by being listed on the stock exchange. BIS central bankers’ speeches that information about their status is reliable and widely available. The level of bank debt will have to be reduced. Banks in turn must accelerate a change that has already begun for some of them. They too are entering a new phase in which it is essential for them to be very well capitalized because of the risks of which we are now all well aware: they must therefore satisfy the general conditions of profitability, transparency and good governance that will allow them to obtain funding at competitive rates (to pass on to lending rates, reducing them) and, if necessary, to raise new capital rapidly and in sufficient quantity. Besides improving their capacity to understand which companies to lend money to, they must also add financial consultancy to their traditional lending activities, thus helping firms to decide the best level and composition of their financial liabilities and supporting their entry to the markets. These new services could build income streams that would at least offset the loss of a part of traditional banking activities. Conclusion We Italians told ourselves from the outset that we were not to blame for the global financial crisis, and it was true: on the eve of the flare-up, we had a financial and a banking system that were largely immune to the problems famously discovered in the Anglo-American systems. Our fault was another: over the preceding decade we allowed the economy to lose strength until it stopped growing, without taking steps to counter a trend whose deep and long-term nature we ignored despite warnings from some quarters. The outcome is before our eyes: we are one of the economies worst hit by the recessive effects of the financial crisis. We worry about the timing and strength of the recovery, about how our country will fare in ten years’ time, about the employment prospects and future well-being of the generation on the threshold of adulthood. A prosperous society knows how to ensure a constant improvement in the quality of life of its members. First and foremost by promoting employment, that is by creating the conditions so that anyone who wants to work, especially at the start of adult life, can find or create a job that is not too unpleasant or ill-paid and that as far as possible fulfils their vocation. Working allows people to plan their future, to access a variety of high quality goods and services, and to grow as a person. This is what we should understand by “development”: a constant, innovative increase in the variety and quality of everything that makes life better, starting from a secure environment, cultural heritage and natural landscape. A well-designed statistical system can calculate national income in such a way as to include the quality of goods and services and not only their quantity. In any case, a static vision of a society that can be crystallized in an eternal present, maintaining resources and production capacity unchanged, is naive and has repeatedly been disproved by history. Stasis is not possible: either we go forward or we will decline, and only in the former case can we mitigate social inequalities. 16 Economic policy today in the advanced countries must first distinguish the vicissitudes of the economic cycle from structural trends and act on both with the appropriate instruments. Employment is the first challenge. An important role in promoting employment and participation in the labour market and aiming for levels and trends in pay that reconcile competitiveness with workers’ aspirations falls to both macroeconomic policies, aimed at restoring steady expansion of aggregate demand and the economy, and structural policies designed to remedy the age-old defects of the labour market and more generally of the Picketty (2014). BIS central bankers’ speeches economic system, which pre-dated the crisis and were merely aggravated by its assault. 17 Structural problems and policies are particularly significant in a number of countries, including our own. For our economy, the return to sustained development cannot be taken for granted, nor is it easily within our reach. Italian history from the Renaissance to the present has witnessed alternating periods of rapid progress and sometimes long phases of stagnation and decline. However, we have no lack of energy, ideas and projects. The financial system is central to the allocation of resources among alternative uses whose contribution to the productivity of firms and the system must be evaluated; this, as I have tried to show in these remarks, is another area of forthcoming structural changes to be assimilated and encouraged. Confidence must be restored on all fronts, the tapestry of legislation, practices, and principles that govern economic activity must be regenerated. The process has begun. We must all become convinced that defending thousands of narrow individual interests, even when they are legitimate, has to take second place where the ability of a national community to generate its own progress is at stake. References Agenda possibile (2013), “Relazione del Gruppo di lavoro in materia economico-sociale ed europea istituito il marzo dal Presidente della Repubblica”, www.quirinale.it/qrnw/statico/attivita/consultazioni/c_20mar2013/gruppi_lavoro/2013–04-12_ agenda_possibile.pdf. Aghion. P. and P. Howitt (1992), “A Model of Growth Through Creative Destruction”, Econometrica, 60(2). Arrow, K. (1962), “The Economic Implications of Learning by Doing”, Review of Economic Studies, 29. Bain & Company and IIF (2013), Restoring financing and growth to Europe’s SMEs, www.bain.com/Images/REPORT_Restoring_financing_and_growth_to_Europe%27s_SMEs. pdf. Beck, T. (2013), Finance and growth: too much of a good thing ?, www.voxeu.org/ article/finance-and-growth . CBI (2012), Financing financing_for_growth.pdf . for growth, http://www.cbi.org.uk/media/1673105/cbi_ Criscuolo, C., P. N. Gal and C. Menon (2014), “The Dynamics of Employment Growth: New Evidence from 18 Countries”, OECD Science, Technology and Industry Policy Papers, No. 14, OECD Publishing. Draghi, M. (2014), Unemployment in the www.ecb.europa.eu/press/key/date/2014/html/sp140822.en.html. euro area, ECB (2014), Introductory statement to the press conference (with Q&A), 04/09/2014, www.ecb.europa.eu/press/pressconf/2014/html/is140904.en.html. Grossman, G. and E. Helpman (1991), Innovation and Growth in the Global Economy, MIT Press. This was the main point of discussion at the latest meeting organized by the Federal Reserve Bank of Kansas City on 22–23 August 2014 at Jackson Hole. See, in particular, the speeches by Yellen (2014) and Draghi (2014). BIS central bankers’ speeches Haselmann, R., K. Pistor and V. Vig (2010), “How law affects lending”, Review of Financial Studies, 23(2). Levine, R. (2014), Finance, long-run growth, and economic opportunity, http://www.voxeu.org/article/finance-long-run-growth-and-economic-opportunity. Panetta, F. (2014), Un sistema finanziario per la http://www.bancaditalia.it/interventi/intaltri_mdir/finanza_rossi/rossi_141113.pdf. crescita, Phelps, E. (2013), Mass Flourishing, Princeton University Press. Piketty, T. (2014), Capital in the 21st Century, Harvard University Press. Romer, P. (1990), “Endogenous Technological Change”, Journal of Political Economy, 98 (5). Rossi, S. (2014), Finanza e crescita dopo la crisi, www.bancaditalia.it/interventi/intaltri_mdir/ finanza_rossi/rossi_141113.pdf . Solow, R. M. (1956), “A Contribution to the Theory of Economic Growth”, Quarterly Journal of Economics, 70 (1). Solow, R. M. (1957), “Technical Change and the Aggregate Production Function”, Review of Economics and Statistics, 39(3). Schumpeter, J. A. (1934), Theory of Economic Development; Stiglitz, J. and Weiss, A. (1981), “Credit Rationing in Markets with Imperfect Information”, The American Economic Review. Stiglitz J. and B. Greenwald (2014), Creating a Learning Society: A New Approach to Growth, Development, and Social Progress, Columbia University Press. Visco, I. (2014), Considerazioni finali sul 2013, www.bancaditalia.it/interventi/integov/2014/ cf_13/cf_13/cf13_considerazioni_finali.pdf VV. AA. (2013), Agenda possibile, Report by the Group on Socio-economic and European Matters set up on 30 March 2013 by the President of the Republic of Italy, www.quirinale.it/qrnw/statico/attivita/consultazioni/c_20mar2013/gruppi_lavoro/2013–04-12_ agenda_possibile.pdf. Yellen, J.L. (2014), Labor Market Dynamics and www.federalreserve.gov/newsevents/speech/yellen20140822a.htm. BIS central bankers’ speeches Monetary Policy, | bank of italy | 2,014 | 9 |
Remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the IEA-ISI Strategic Forum 2014, Final Roundtable "Accounting for the long-term costs of the recession", Rome, 23 September 2014. | Ignazio Visco: Accounting for the long-term costs of the recession Remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the IEA-ISI Strategic Forum 2014, Final Roundtable “Accounting for the long-term costs of the recession”, Rome, 23 September 2014. * * * 1. The legacies of the Great Recession are many and multifaceted; they not only affect current cyclical developments, but may also have permanent bearings on our economies. However, today’s difficulties and opportunities, as well as tomorrow’s prospects, are the result of deep underlying forces that were already reshaping the functioning of the world economy well before the Great Recession began. A. Crisis legacies for economic growth 2. In advanced countries such as the US and the UK, GDP (imperfect an indicator as it may be, especially in the face of the increasing role of digitisation) has now overtaken its pre-crisis level: however, the growth rate remains lower than before 2008. In the euro area as a whole, current GDP still remains below its pre-crisis level, to which it might return late next year. It should also be underlined that the weak recovery is no longer confined exclusively to stressed countries of the area. 3. What is more worrying is that the crisis may have left lasting scars. The high correlation between the increase in estimated output gaps since 2007 and the fall in the (estimated) growth rates of potential output suggests that lower investment and higher unemployment (or under-employment) may have had an impact extending well beyond the current cycle. 4. This is particularly worrisome for countries with high public debts, whose sustainability requires a return to steady economic growth, and which may also suffer, as is presently the case in the euro area, from excessive disinflation. And this is why structural reforms and accommodative monetary policy are so much in demand these days. 5. That the legacies of the crisis go well beyond the short term is best epitomized by ongoing talks about risks of hysteresis (the extent to which cyclical developments affect an economy’s longer-term dynamics) and the revival (by Larry Summers) of Alvin Hansen’s 1930s hypothesis of secular stagnation. In essence, this hypothesis relates to factors that generate permanently higher savings and lower investment, in a context where monetary policy is unable to reduce the real interest rate to the required (negative) equilibrium level because of the zero lower bound. 6. A second version of the secular stagnation hypothesis, more than focussing on the demand side, contends that the most productivity-boosting innovations have already been invented. Critics of this version reply by underlining that the digital revolution has yet to deploy its effects on productivity or that the potential from frontier research fields such as robotics and genomics is powerful. B. Technological progress and the labour market 7. This brings us to the role of technology, and to the other major structural forces that were changing the world economy well before the Great Recession: globalisation and demographic trends. 8. The labour market is where we can best see the intertwining between structural changes and effects of the crisis. The latter has resulted in a dramatic increase in unemployment: although in the US and the UK the labour market has recovered, with unemployment rates back to around 6 percent, in the euro area unemployment remains only slightly below its peak levels, at 11.5 percent in July 2014. In Italy the unemployment rate has more than BIS central bankers’ speeches doubled from 6 to over 12 percent since 2007. Youth unemployment has shot up from 20 to over 40 percent. 9. Furthermore, there is also a broader tendency in advanced countries of employment rates to decrease. Between 2007 and 2013 employment has fallen in the US from 72 to 67 percent of the working age population; in Italy from 59 to 56 percent (from 25 to 16 percent among the youth). 10. The critical point, from a policy perspective, is to what extent the rise in unemployment is structural rather than cyclical. In principle, fighting the former is more difficult than sustaining aggregate demand, as it normally implies the reallocation of labour across sectors (and countries): many displaced workers may find that their skills are no longer in demand in the aftermath of the crisis. Long-term unemployment in the euro area doubled from the pre-crisis level, to over 6 percent of the workforce. Globalisation and technological progress are eroding labour demand in Europe. 11. In the last two centuries, technological progress has generated widespread wealth and new employment opportunities. Product innovations and automation may have caused job losses in the innovative sectors in the short term, but quickly created new employment opportunities for the economy as a whole, in a virtuous sequence of cost reductions and productivity increases, income growth, increased demand for new goods and services. 12. Today, however, while recognizing the great benefits for society as a whole that technological progress generates in the longer term, a distinctive property of the innovations triggered by the digital revolution is being emphasized: the high speed with which new technologies tend to reduce the use of labour, with a major impact, both qualitative and quantitative, on employment. In other words, “technological unemployment” is placed among the various driving forces behind the currently high unemployment rates and sluggish wage and income developments. 13. New information and communication technologies are complementary to managerial and intellectual jobs but provide a substitute for more routine jobs. The ICT revolution has resulted, in the US and in other countries, in a polarisation of professions, with job increases concentrated either in the low-paying service sector or in the high-paying, highly educated job positions, at the expense of the middle-skilled jobs. Furthermore, there are expectations that automation in the future will lead to a new wave of technological revolution not only from areas such as robotics or genomics but also from artificial intelligence developments that may further challenge the demand for both lower- and higher-skilled jobs. 14. Given the country’s specialisation in traditional products, Italy has so far suffered the most from the impact of globalisation, and the ensuing surge of competition from emerging markets, rather than from technology. But Italy is of course not immune to the challenges posed by technology. A frequently cited 2013 study by Oxford University economists, Carl Frey and Michael Osborne, estimates that 47 percent of current jobs in the US would be at risk of being automated possibly in a decade or two. By applying the risks of computerisation generated by this work to data on European employment, estimates have been recently extended to European countries in a recent paper by Bruegel’s fellow Jeremy Bowles. With all the caveats that such suggestive exercise necessarily requires, Italy finds itself among the countries where a larger number of jobs would be vulnerable to computerisation: 56 percent versus 51 percent for Germany, 50 for France, 47 for the UK. We may not yet have seen the full impact of technological innovation. C. Investment 15. This consideration must be seen against the substantial slowdown in the accumulation of capital since the crisis erupted. Public and private real investment fell in Italy by over 30 and 25 percent, respectively, between 2007 and 2013, well above the already high average of 20 percent recorded for the euro area as a whole. BIS central bankers’ speeches 16. Despite the low interest rates allowed by the accommodative monetary policy, widespread uncertainty about prospective demand growth and the deleveraging by overindebted firms have held back private investment. In stressed euro-area countries, these difficulties have been compounded by limited access to credit, because of balance sheet repair in the banking sector, and the increased cost of capital, owing to financial fragmentation. Fiscal consolidation has often implied massive cuts in public investment, which may cast a shadow on potential future output. 17. Investment is the linkage between today’s demand and tomorrow’s supply. Reviving investment – public and private, national and European – would thus go a long way towards addressing both cyclical weaknesses and structural challenges to future potential growth. Indeed, as it has been suggested inter alia by Barry Eichengreen, lack of investment in infrastructure, education and training is another possible source of secular stagnation. D. Concluding remarks 18. In many respects, we are travelling through unchartered territories. Refocusing economic policies on sustaining aggregate demand, in particular stimulating investment, is a necessity. On the other hand, the forces of technological progress imply that much of capital accumulation may further save on labour inputs. Be it the legacy of the Great Recession or the outcome of more engrained trends, some of our traditional policy tools appear to be increasingly ineffective. 19. Central banking has devised new innovative ways to respond to the crisis. Much closer attention is now being paid to the responsibilities of monetary policy for financial stability and, more generally, to interactions and possible conflicts between policies that foster price and financial stability. Macro-prudential policies now feature highly on the agenda of financial authorities. With policy rates in major advanced economies virtually at the zero lower bound, unconventional monetary policies are increasingly considered. 20. Yet, the main challenge is posed by the developments in the real economy. It is here that we must exercise our ingenuity. The business environment must be made more conducive to private investment. And investment in infrastructures has to return to be high in the policy agenda. In the euro area, policies should aim at keeping the cost of capital low, developing capital market sources of finance to complement bank loans, implementing structural reforms to improve expectations of more favourable aggregate demand going forward, reducing policy uncertainty. 21. In Italy, the most urgent interventions are those which safeguard legality and efficiency in public administration. To repeat what I said last May in my concluding remarks to the Bank of Italy’s meeting of shareholders: “Corruption, criminal activity and tax evasion not only undermine the community but also distort the behaviour of economic agents and market prices, reduce the effectiveness of government action, increase the tax burden on those who do their duty, and restrict productive investment and job creation. Well-functioning public administration improves the operation of markets and competition, reduces firms’ costs, and is reflected in the quality and cost of public services and thus on the tax burden. The efficacy of the reforms depends on it.” 22. These policy actions should not be eluded. For them to be effective, they must be seen as a part of a fully-fledged strategic reasoning on the prospective functioning of our economies. More generally, while we try to better understand the challenges posed by structural and technological change, there are questions that it is fundamental to address. Among them: How should the education system adapt to enable the teaching of those skills essential to keep up with new technologies? How can we enable displaced workers to acquire skills which will not become, or are less likely to become, redundant through computerisation? How can public policy smooth the social impact of technological progress and allow a wider distribution of its fruits? BIS central bankers’ speeches | bank of italy | 2,014 | 9 |
Speech by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy and President of the Insurance Supervisory Authority (IVASS), at 46th Day of Credit, Rome, 1 October 2014. | Salvatore Rossi: Banks and insurance companies – a common path for growth Speech by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy and President of the Insurance Supervisory Authority (IVASS), at 46th Day of Credit, Rome, 1 October 2014. * * * The evolution of the world financial system The international debate on financial systems features an apparent paradox: throughout the world there are complaints about the lack of financial support, especially bank credit, for infrastructure and for small and medium-sized enterprises; at the same time there is alarm about the heightened commitment of entities other than banks to financing the real economy. The alarm stems from the fact that, compared with banks, many of these entities are subject to less regulation and supervision or none at all. The two concerns arise in different contexts and for different reasons, but they are often found together in the international fora in which the conditions of the global economy are discussed; this gives the impression of conflicting objectives. The impression is false, but it is important to spotlight the way in which the two lines of analysis can be reconciled in a single, harmonious economic policy prescription. The latest meeting of G20 Finance Ministers and Central Bank Governors ten days ago in Cairns, Australia, provides a good example of the joint presence of these two apparently conflicting concerns. The final Cairns communiqué clearly expresses the unanimous belief among the twenty countries, which produce more than 80 per cent of world GDP, that in the present phase the critical variable for stimulating demand and increasing economic growth is investment: investment in infrastructure, in public-private partnership; and investment by firms and especially SMEs. If there are difficulties, as there may be, in financing the desired additional expenditure via the markets and traditional intermediaries, it will be necessary – the world’s leaders maintain – to promote other financial channels, such as a transparent and efficient market for securitizations, with a greater role for institutional investors, including insurance companies. Another crucial passage of the communiqué was devoted to the progress of the work that the G20 commenced immediately after the outbreak of the global crisis with the aim of constructing a new framework of rules for the financial system, to make it more resilient and less exposed to crises. In this context, so-called shadow banking has always been seen as a worrisome source of risk. Shadow banking means financing of the real economy intermediated by entities that are not banks but act, at least in part, as if they were. This is undoubtedly the case of funds channeled to firms by an institutional investor through securitized instruments created, for example, by a special purpose vehicle, exactly the type of non-bank financing invoked by the previous passage. Can the two requirements be reconciled? As in every trade-off between risk and opportunity, it is a question of curbing the former without sacrificing the latter. By weakening banks, the crisis has shifted the axis of the financial system in the advanced countries from credit intermediation to the markets, from a bank-based to a market-based structure. The partial withdrawal of the banks, forced by more stringent rules and the cyclical downturn to deleverage, has not only prompted an increase in firms’ direct funding in the markets, through bond issues, but has also made room for other intermediaries, driven in turn by the need to provide their investors with acceptable yields in a world of very low or nil interest rates. BIS central bankers’ speeches This development certainly entails a danger for financial stability. If part of the traditional credit function is diverted in practice to channels that are “in the shadows” with respect to supervisors; if the actors are willing to take greater risks to achieve higher yields than those corresponding to today’s highly accommodative monetary conditions; if they are free to do so because they are untrammeled by rules and controls, the experience of the global crisis of six years ago teaches that systemic instability is just around the corner. Nevertheless, the real economy does need finance. Above all when it is a question of getting stagnant economies moving again, any financial instrument or institution that can effectively deliver funds to entrepreneurs with technological and business projects, especially innovative ones, is welcome. The Eurosystem recently announced a vast programme of purchases of asset-backed securities based in part on bank loans to SMEs. The obvious solution to the dilemma lies in extending the perimeter of supervision to institutions not now encompassed. This is an arduous task, necessitating a high degree of international cooperation, given the cross-border interconnections and the associated opportunities for regulatory arbitrage, and requiring regulators to keep up with incessant financial innovation motivated in part precisely by the desire to escape controls. This is the task that the G-20 assigned in 2009 to the Financial Stability Board, whose past achievements and likely future progress were discussed in the meeting in Cairns. “Finance for growth” in Italy I come now to the implications of these global trends for Italy. How to ignite a cyclical recovery in Italy? And once the upswing is under way, how to get our economy back onto a path of lasting growth? These are questions we ask ourselves repeatedly. In the longer term the problem is one of production structure, competitiveness, technology; it requires a transformation of our society to enable it again to produce income and widespread prosperity: profound changes, twenty years overdue, admitting no further refusal or delay. Economic and social policy in Italy has set objectives which are generally consistent with these needs; it is pursuing them amidst the difficulties posed by a society many of whose members are reluctant to recognize the paths of the future. In the short run the problem is to lift firms’ investment decisions from the shoals, so that they drive a recovery of demand. After six years of nearly uninterrupted recession, Italian firms are in generally poor shape. Still, a not insignificant number, especially among the exportoriented, are profitable and have investment plans on hold as they wait for the uncertainties about the future to dissipate. Others are in greater difficulty, more concerned for the moment with surviving than investing, but they preserve a potential for recovery. Still others are inexorably outside the market. Finally, entrepreneurial energies outside the ranks of existing firms are pressing to take form: new cells that could replace the ones that are no longer vital. An efficient financial system should: help persuade the sound firms not to put off the necessary investments any further; distinguish between the firms with potential and those without it, supporting only the former; encourage nascent firms and start-ups to strengthen themselves and grow quickly. To achieve all this, a diversified and differentiated supply of finance is obviously preferable. On a recent occasion I recalled that the Italian financial system is, instead, still strongly centred on bank intermediation. 1 I cited some statistics: At the end of last year bank loans accounted for 40 per cent of the total financial liabilities of households and firms (financial debt plus corporate equity), compared with 15 per cent in the United States, 23 per cent in “Finance for growth”, speech delivered in Sondrio at Banca Popolare di Sondrio, 12 September 2014. BIS central bankers’ speeches France and 30 per cent in the United Kingdom. Only Germany, another bank-centred” economy, had a share comparable to Italy’s. Equity investment by venture capital and private equity funds, which specialize in assisting the growth of firms, amounts to 0.2 per cent of GDP in Italy, as in Germany, or half as much as in France and a fifth as much as in Britain. Italy’s financial system needs to evolve towards a structure in which firms are less dependent on bank credit and markets and institutional investors play a greater role as channels and providers of external financing for the productive economy. The process is a difficult one, impeded by the reluctance of Italian SMEs to open up to the capital markets, either in terms of ownership control or even just of transparency of information. Progress along this path, which is already under way in other economies, is particularly arduous in Italy because of the anomalies of its SMEs compared with those of the other advanced countries, starting with their considerably smaller size. Insurance and banks: strangers or companions? The need to revive private sector investment and cut the cord that often binds the livelihood of SMEs to the availability of bank credit has led the Italian Parliament to intervene several times in the last two years: first with the Monti Government’s “Development Decree” in June 2012 2 and then with the Letta Government’s “Destination Italy Decree” in December 2013. 3 The two laws had a common objective: to create a market for mini-bonds. On the supply side they introduced legal and tax incentives for the issuing firms, while on the demand side they broadened the possibilities for insurance companies and pension funds to invest in them. The “Competitiveness Decree” 4 passed by the present Government in June is a further step in promoting channels of finance for SMEs alternative to bank credit, including securitized instruments with bank loans as underlying assets to be placed with institutional investors and direct lending to SMEs by the latter. In short, this would appear to be a move in favour of shadow banking, albeit a limited and controlled one. I have just two comments to make on this point, one of a general nature, the other concerning the specific instruments chosen. On a general level, we should not delude ourselves as to the immediate stimulus to private investment that can be achieved by increasing the supply of finance to firms. Most of the investment plans ready but now on hold have been halted not by a lack of funds but by uncertainty and cautiousness. Above all, what can unblock the plans is the dissipation of those causes by sound and efficient policies. My second observation concerns the new form of cooperation between insurance companies and banks prefigured by these recent laws. Insurance companies and banks (I am talking here about traditional retail banks) perform quite distinct functions within the economy, but they nevertheless share some important features that have led several countries, Italy included, to group them under the same supervisory umbrella. Both raise funds from the general population in exchange for services rendered: transfer of risks, in the case of insurance companies; deposit and payment, in the case of banks; in both instances the relationship with the customer is essentially fiduciary. Both types of institution must invest the funds gathered so as to earn income with which to meet their commitments. Where they differ is in their time horizon: insurance companies collect premiums on long-term contracts, whereas banks take a large number of demand Decree Law 83/2012, amended and converted into Law 134/2012. The decree was recast in October by the second Development Decree (Decree Law 179/2012, amended and converted into Law 221/2012). Decree Law 145/2013, amended and converted into Law 9/2014. Decree Law 91/2014, amended and converted into Law 113/2014. BIS central bankers’ speeches deposits. This means that an insurance company’s investment assets should preferably be at long term; those of banks may be as well, but where they are, the bank runs the risk implicit in every maturity mismatch. Insurance companies and banks have already developed some forms of collaboration, mainly based on agreements following the bank insurance model (bancassurance). However, these are partnerships of a purely commercial nature: the bank makes use of its branch network and customers in order to sell the partner company’s insurance products in return for a fee. But each party continues to engage in its own line of business. What we are talking about today, particularly in Europe and even more so in Italy, is a different type of collaboration, in which insurance companies actually supply credit, for the most part to comparatively risky and opaque customers like SMEs. In short, the two lines of business are intertwined. Is this reasonable? Is it proper? The insurance supervisor Ivass, which has to turn the provisions of Government and Parliament into operative regulations, has had to reflect on this issue strictly from the point of view of its mandate – the prudential supervision of insurance companies in the interests of the insured. The question we asked ourselves was whether our rules to safeguard the prudent investment of the companies’ technical provisions were not perhaps preventing, in the light of the evolution of the market and the regulatory framework, greater diversification of risk, which is the first prudential line of defence, not to mention preventing the achievement of profit levels sufficient to cover the companies’ guaranteed obligations. We answered: possibly so; and especially considering that the imminent Solvency 2 regulatory framework will sweep away all the old mechanical rules and replace them with methods for assessing the risk of each investment. Accordingly, already with the implementation of the Destination Italy decree, we created new asset classes to accommodate both direct investment in mini-bonds and commercial paper (up to 3 per cent of the technical provisions), and investment via securitization (again, up to 3 per cent of the technical provisions). In addition, we have raised the limit on exposure to a single fund within the class of “alternative investments” from 1 to 3 per cent for funds that invest in mini-bonds and securitized instruments. The potential for using these wider limits, in effect since last March, is equivalent to almost €30 billion. Although the market for these instruments has already started to grow, interest on the part of insurance companies has so far been negligible. The Competitiveness decree represents a sea change, allowing insurance companies to make direct loans (but not to individuals or micro enterprises), and to use them to cover technical provisions, together with the related securitizations. Ivass participated in the preparatory technical work for these new regulations, conducted by the Ministry for the Economy and Finance and the Ministry for Economic Development. We worked in the best spirit of collaboration, always pursuing, as was our duty, our prudential aims. In this case as well, we felt that the proposed opening could work in the direction of sounder and more prudent management of insurance companies, providing them with a new “asset class” that would enable them more easily to reach the point on the efficient risk/return frontier most consistent with the obligations deriving from insurance liabilities. One aspect we insisted on was that the insurance company should be accompanied by a bank both in the initial phase of borrower selection and at the later stages. This point was included in the text of the decree. However, in the decree’s conversion into law the requirement that the bank and the insurance company should form a partnership, and in particular the provision that the bank should hold a significant economic interest until maturity, was almost completely voided; prudential concerns were overridden by the urgent desire to supply the economy with new credit from new institutions. As currently formulated, the law entails a risk of “adverse selection” and “moral hazard”: at worst, that is, a bank could foist its most impaired loans on BIS central bankers’ speeches an insurance company and then withdraw from the partnership. To keep this from happening, insurance companies will have to equip themselves adequately to assess the creditworthiness of a business, as if they were themselves banks. This is no easy task: it means having an additional technical unit, specialized in a task that has never been typical of insurance companies. Very big companies could possibly do it easily enough, but the smaller ones will be exposed to the danger of being left in the lurch. Ivass will have to authorize insurers that want to venture into this business; it will do so by verifying the presence of technical-organizational arrangements that enable them to form an independent judgement on the loans to be acquired or granted. Two days after the decree’s conversion into law, Ivass held a public consultation on the implementing rules, which can be summed up as follows. The insurance company will have to submit to Ivass a business plan that is wholly contemplated within the framework resolution on investment and that contains sufficiently detailed information to enable the Authority to make its own evaluation and verify that the criteria set out in the law are met. In these assessments special attention will be paid to the extent and duration of the partner bank’s participation. If the insurance company does not intend to avail itself of the support of a bank it must describe the organizational arrangements taken for the screening and monitoring of borrowers and, using best banking practices, demonstrate its ability to understand and manage credit risk. Within the macro class of “loans,” different investment classes are envisaged, to which specific caps and procedures are applied within the upper limit set by Community law (5 per cent of the technical provisions). The criteria introduced by Ivass to distinguish between the various classes are, first, the presence and permanence of a partner bank together with a number of requirements relating to the borrower (credit rating and the certification of the accounts). The class of securitizations has been broadened to include “loan securitizations” which, along with others, can admit total investments of up to 5 per cent of the technical provisions. We shall see in the months ahead whether or not insurance companies show significant interest in this new business. From our occasional contacts to date, some interest has emerged in the funding of major infrastructure projects but little in lending to SMEs. Given present cyclical conditions, insurance companies are certainly driven to seek higher yields than those prevailing in traditional investment classes, but they are well aware of the cost of equipping themselves to take on new and very risky tasks. For higher yield means higher risk; and no one more than insurance companies has this maxim, frequently ignored by others, inscribed in their DNA. One way of encouraging them could be to offer a government guarantee on the assets to be acquired. I have already said elsewhere that this would be a rational move on the part of the public sector, because it would remedy a potential “market failure” at a cost that will be both modest and deferred in time. 5 But insurers could also help in another way to ease the residual tensions in credit supply, especially to SMEs, namely simply sticking to their traditional business and increasing their coverage of the risks to which SMEs are typically exposed (fire, theft, liability). It is no secret that the better-insured businesses – size, location and sector of activity being equal – find it easier to access credit and at more favourable conditions. * * * The insurance and the banking communities can both contribute to the transformations of Italy’s financial landscape that are now indispensable if this country is to return to growth. I “Finance for growth”, op. cit. BIS central bankers’ speeches am aware that the issues I have dealt with are small ones. But I will not yield to the temptation to say “it will take a lot more than that”. Let us all start with the small things within our ken. Let us avoid the danger of confusing two different trades like the insurer’s and the banker’s, but at the same time let us not be held back by fear of the new. BIS central bankers’ speeches | bank of italy | 2,014 | 10 |
Speech by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy, at the University of Verona, University complex of Vicenza, Vicenza, 19 November 2014. | Salvatore Rossi: Monetary policy and the independence of central banks – the experience of the European Central Bank in the global crisis Speech by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy, at the University of Verona, University complex of Vicenza, Vicenza, 19 November 2014. * 1. * * The independence of central banks in theory and in history1 We have been talking about the independence of central banks almost from the time of their inception. In an essay of 1824 David Ricardo accused the Bank of England, founded more than a century earlier, of submitting to the power of the executive. 2 Ricardo identified the three pillars of central bank independence: institutional separation of the power to create money from the power to spend it; a ban on the monetary funding of the State budget; and the central bank’s obligation to give an account of its monetary policy. Ricardo’s suggestions were taken up by the Brussels Conference of 1920, held under the aegis of the League of Nations with the aim of identifying the best policies to counter the economic and financial crisis that followed the First World War. Price stability was indicated as the primary objective of monetary policy but – as the Final Report of the conference maintained – if it was to be achieved, it had to be entrusted to central banks that were independent of their governments. 3 These principles were forgotten for many years after the Second World War. The conviction that a certain degree of inflation was necessary to support employment and growth came to the fore in economic thought and in the minds of policy makers. In many countries monetary policy was dominated by budgetary requirements (fiscal dominance) and central banks acted as buyers of last resort of government securities when they came onto the primary market. 4 The independence of central banks enjoyed little institutional protection. The stagflation of the 1970s suddenly brought to light what farsighted economists, such as Edmund Phelps, had already foreseen in the previous decade: 5 in the short term there may be a trade-off between inflation and unemployment, but not in the long term. This radical rethinking of the theory was accompanied by profound changes in the organization and behaviour of central banks. Economic literature once again looked at price stability as a supreme value and pointed to two prerequisites: the independence of the institutions called to guarantee it, i.e. central banks, and the adoption on their part of explicit objectives. This section is based in part on Salvatore Rossi (2013), “Post-crisis challenges to central bank independence”, speech given at the LBMA/LPPM Precious Metals Conference http://www.bancaditalia.it/interventi/intaltri_mdir/300913/rossi_300913.pdf. David Ricardo (1824), Plan for the Establishment of a National Bank, John Murray, London. Franco Spinelli and Carmine Trecroci (2006), “Maastricht: New and Old Rules”, Open Economies Review, Vol. 17, pp. 477–492. For the Bank of Italy, see Eugenio Gaiotti and Alessandro Secchi (2013), “Monetary policy and fiscal dominance in Italy from the early 1970s to the adoption of the euro: a review”, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), No. 141. See Edmund S. Phelps (1967), “Phillips Curves, Expectations of Inflation and Optimal Unemployment over Time”, Economica, Vol. 34, pp. 254–281 and Edmund S. Phelps (1968), “Money-Wage Dynamics and LaborMarket equilibrium”, Journal of Political Economy, Vol. 76, pp. 678–711. BIS central bankers’ speeches The need for a central bank to declare an explicit objective, thus making it more difficult for the political authorities to change it, was already mentioned in an article by Milton Friedman of 1962 entitled, significantly, “Should there be an independent monetary authority?” 6 Friedman asks “how else can we establish a monetary system that is stable, free from irresponsible governmental tinkering and incapable of being used as a source of power to threaten economic and political freedom.” He counted on independent experts, although he ruled out entrusting them with wide powers of discretion, preferring fixed rules that assign precise tasks and objectives to monetary policy. In the 1970s Robert Lucas, Thomas Sargent and others complicated the picture: they did not think it was sufficient to assign the task of maintaining price stability to the central bank; private agents have rational expectations, therefore monetary policy must be time consistent to be credible. 7 A government will always be tempted to exploit the short-term trade-off between growth and inflation, without worrying about the long-term costs. To avoid this risk a central bank has to be really independent. 8 Numerous empirical checks supported these theoretical assumptions. 9 2. The European system of central banks The Maastricht Treaty, signed in 1992, drew on this new paradigm. Article 127 of the current version of the Treaty on the Functioning of the European Union, which incorporated the principles enshrined in the Treaty of Maastricht, establishes that “The primary objective of the European System of Central Banks (ESCB) … shall be to maintain price stability”. 10 The Governing Council of the European Central Bank (ECB) later explained that price stability should be understood as an inflation rate below, but close to, 2 per cent in the medium term. Instead independence is affirmed in Article 130, which states that “…neither the European Central Bank, nor a national central bank, nor any member of their decision-making bodies shall seek or take instructions from Union institutions, bodies, offices or agencies, from any government of a Member State or from any other body. The Union institutions, bodies, offices or agencies and the governments of the Member States undertake to respect this principle and not to seek to influence the members of the decision-making bodies of the European Central Bank or of the national central banks in the performance of their tasks.” The Treaty thus establishes the obligations both for the monetary policy authorities, which cannot bend to political pressure, and for governments, which cannot exercise it. Milton Friedman (1962), “Should There Be an Independent Monetary Authority?”, in Leland B. Yeager (ed.) In Search of a Monetary Constitution, Harvard University Press, Cambridge, Massachusetts. See, among others, Robert Barro and David Gordon (1983), “Rules, Discretion, and Reputation in a Model of Monetary Policy”, Journal of Monetary Economics, Vol. 12, No. 1, pp. 101–122. See, for example, Kenneth Rogoff (1985), “The Optimal Degree of Commitment to an Intermediate Monetary Target”, Quarterly Journal of Economics, Vol. 100, No. 4, pp. 1169–1189 and Carl E. Walsh (1995) “Optimal Contracts for Central Bankers”, American Economic Review, Vol. 85, No. 1, pp. 150–167. Alberto Alesina and Lawrence H. Summers (1993), “Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence”, Journal of Money, Credit and Banking, Vol. 25, No. 2, pp. 151–162. Article 127 also states that “Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Union with a view to contributing to the achievement of the objectives of the union as laid down in Article 3 of the Treaty on European Union”, which include full employment. On the ranking of the ESCB’s objectives, see, however, Perassi (2011), “La Banca centrale europea”, published in Enciclopedia del diritto, Annali IV, Giuffrè Editore, Milan. BIS central bankers’ speeches It is interesting to note that the Treaty endorsed the proposal that Ricardo had formulated almost two centuries earlier, providing the legal basis for the three principles he developed. The institutional separation between the public powers of creating and spending money was established under Article 128, which states that “The European Central Bank shall have the exclusive right to authorize the issue of euro banknotes within the union.” Monetary funding of the State is prohibited by Article 123: “Overdraft facilities or any other type of credit facility … in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them … of debt instruments.” Lastly, Article 284 obliges the ECB to send an annual report to the European Parliament, the Council and the Commission. 11 This reporting requirement, linked with a clear mandate, means that the monetary policy authority can be evaluated ex-post and is therefore accountable. So far we have looked at the regulations. What about the substance? A questionnaire was sent out at the end of the 1990s to a large number of central banks, which were asked what independence meant to them. Some 80 per cent of the replies to this question mentioned the freedom of the central bank to choose the most suitable instruments for its objectives; 12 in short, real operational independence. We should not be surprised: it has been said that the practice of central banking is more of an art than a science. 13 In the field of the natural sciences, specific operational instruments follow from quantitative analysis. Monetary policy also makes use of models, but it cannot do without qualitative evaluations. Paul Samuelson said, “I would rather have Bob Solow than an econometric model, but I’d rather have Bob Solow with an econometric model than Bob Solow without one.” The Statute of the ESCB and the ECB permits them to use a wide range of instruments and to choose any method of monetary control they consider appropriate. 14 We know however that real functional independence can only be evaluated on the basis of past experience: we need to check that the instruments available to the central bank, albeit numerous, are not in fact insufficient to address unexpected problems and to be sure that at the moment the need emerges for new instruments there will not be any constraints on operational autonomy. 3. The Eurosystem and the global financial crisis The long period known as the Great Moderation, lasting up to the outbreak of the global financial crisis, did not provide a good test of the efficacy of the Statute and operating arrangements of the Eurosystem. Central banks in all the advanced countries successfully Other reporting obligations are dealt with in Article 15 of the Statute of the ESCB and the ECB, which requires the ECB to draw up and publish reports on the activities of the ESCB at least quarterly. Lavan Mahadeva and Gabriel Sterne (2000), Monetary Frameworks in a Global Context, Routledge, London. There were 60 replies, of which 23 from advanced countries and 37 from emerging and developing countries. See Alan Blinder (1997), “What Central Bankers Could Learn from Academics-and Vice Versa”, Journal of Economic Perspectives, Vol. 11, No. 22, pp. 17. Article 18 of the Statute of the ESCB and the ECB attached to the Treaty affirms that they may “operate in the financial markets by buying and selling outright (spot and forward) or under repurchase agreement and by lending or borrowing claims and marketable instruments, whether in Community or in non-Community currencies, as well as precious metal and conduct credit operations with credit institutions and other market participants, with lending being based on adequate collateral.” Article 20 authorizes the Governing Council to decide, by a majority of two thirds of the votes cast, upon the use of such other operational methods of monetary control as it sees fit. BIS central bankers’ speeches preserved price stability with conventional policy instruments, thanks to such formidable facilitating factors as the rise of the emerging economies and the intense downward pressure on prices that they exerted. The crisis changed everything. The exceptional monetary expansion that was required of the central banks, still haunted by the spectre of the errors committed during and after the Great Depression in the 1930s, required unconventional policy measures: unlimited provision of liquidity, purchases of government and private-sector securities on the secondary market, currency swaps, forward guidance, and much more. The effective functional independence of the Eurosystem was demonstrated by the speed with which it deployed a panoply of unconventional measures in response to the crisis. The ECB was the first central bank to counter interbank market strains with injections of liquidity, totaling €100 billion already in August 2007. 15 After the default of Lehman Brothers, when the crisis reached a magnitude that prompted fears of the collapse of the entire global financial system, the ECB not only rapidly lowered its policy rates but also introduced fixed-rate, fullallotment auctions for central bank refinancing and broadened the range of assets eligible as collateral. In this way, as early as 2008 the European central bank had expanded its balance sheet by 60 per cent. 16 In 2009 and 2010, the severe disruption of financial systems produced by the crisis and the consequent recession were compounded, in Europe, by the “sovereign debt” crisis of some euro-area countries. The revelation of the true state of the public finances in Greece resulted in the collapse of international investor confidence – at first just in Greece; but then, in rapid succession, doubts arose over the sustainability of the public debt in Ireland, because of the bursting of the real estate bubble there and the consequent banking crisis, and in Portugal, given that country’s persistent macroeconomic disequilibria. Beginning in the summer of 2011, following the announcement of the bail-in of private investors in the restructuring of the Greek debt, the strains turned systemic and spread to Spain, which was suffering a sharp contraction of the real estate market that impacted on the most exposed banks; and lastly to Italy, vulnerable for its large public debt and apparent inability to generate economic growth, even in the longer term. Up until then, the illusion had prevailed that the Eurosystem could conduct monetary policy simply treating the euro area as a single nation. The doubts voiced by some analysts about the logical consistency of such a model had been muted by the incontrovertible successes of a decade of single monetary policy. Let me recall two of those expressions of doubt: Tommaso Padoa-Schioppa’s “currency without a State” 17 and Carlo Azeglio Ciampi’s “limp”. Ciampi observed that “at the very moment the euro was created, it was born with a limp, an asymmetry between monetary policy and economic policy, the former assigned to the European Central Bank and the latter still largely the province of the national governments. This limp, which we denounced some time ago, is being corrected too slowly.” 18 Instead, it was thought that this hobbled Europe was more than good enough to keep up with the swift pace of the modern economy. On the morning of 9 August 2007, following the sudden drying-up of trading and the consequent rise in shortterm money market rates, the ECB intervened with a fine-tuning operation of one day maturity, allotting some €95 billion to 49 banks. Similar operations were conducted in the days that followed. Martina Cecioni, Giuseppe Ferrero and Alessandro Secchi (2011), “Unconventional monetary policy in theory and in practice”, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), No. 102. He used the expression on a number of occasions. For one, see Tommaso Padoa-Schioppa (2004), L’euro e la sua banca centrale. L’unione dopo l’Unione, il Mulino, Bologna. Public address as part of President Ciampi’s meetings with political, civil and military authorities in Pistoia, 16 September 2002. BIS central bankers’ speeches The sovereign debt crisis was a watershed. It made it glaringly clear that the incompleteness of European integration could compromise monetary policy, hindering its transmission between countries and undermining the central bank’s functional independence. This for three principal reasons. First, the sovereign debt crisis stirred fears that the euro could break up. An eventuality that until then had been judged to be of probability zero now, in international eyes, entered the sphere of possibility. The consequence, which materialized mostly in 2011, was investors’ demand for high premiums on government bonds in the countries of southern Europe. The lack of fiscal union thus came to the fore, and the policy limp could be seen in all its destabilizing potential. Second, this resulted in an accentuated segmentation of the European financial market along national lines, marking a brusque regression in the laborious process of integration that had been advancing for a decade-and-a-half. The flows of capital between the North and the South of what should be a single currency area were interrupted. 19 Third, all of this engendered a corresponding segmentation of the banking market. The banks whose balance sheets abounded in the government securities that were under fire in the marketplace were subject to the same fears as their “sovereigns”. 20 Everyone knows that banks everywhere tend to have a larger portion of their assets in their home country’s government securities. At the origin of the risks investors suddenly perceived there were also, in the countries under pressure, serious disequilibria that had built up well before the global financial crisis. These weaknesses, varying in extent from country to country, comprised excessive public or private debt, poor competitiveness, dubious prospects for economic growth, and external imbalances. The single currency had shrouded the markets’ judgments in a veil of uniformity that was pierced by the sovereign debt crisis, revealing the dissimilarities between the debtor countries. But this must not be allowed to hide the essentially systemic nature of the problems that have struck the entire area. 4. What could the ECB do? The ECB reacted. In May 2010 it activated the Securities Market Programme for purchases of public- and private-sector securities on the secondary market; the purchases were extended to Italian and Spanish securities in the summer of 2011. In December of that year two longer-term refinancing operations were announced, with the aim of countering the effects that the strains on government securities and capital outflows were having on the wholesale funding of banks in several euro-area countries. In August 2012, amidst resurgent fears of euro reversibility, the ECB announced that it stood ready to carry out outright monetary transactions: secondary-market purchases of government securities issued by countries that agreed to abide by a European programme of financial assistance. To date, no such purchases have been made, nor have the related acts been formally adopted, pending a ruling by the European Court of Justice on the German Constitutional Court’s referral. But their announcement alone was enough to calm the markets. The effectiveness of these measures must not be underestimated. They lessened the tensions in the money and capital markets and averted a sharper contraction in credit, thereby braking the deterioration of the monetary policy transmission mechanism. According Martina Cecioni and Giuseppe Ferrero (2012), “Determinants of TARGET2 imbalances”, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), No. 136. Paolo Angelini, Giuseppe Grande and Fabio Panetta (2014), “The negative feedback loop between banks and sovereigns”, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), No. 213. BIS central bankers’ speeches to studies by the Bank of Italy, the overall effect on Italy’s GDP of the measures I have listed can be estimated at a little less than three percentage points in the two years 2012–13. 21 These measures also highlighted the operational autonomy of the Eurosystem, which was able to bring a wide array of instruments to bear on the different manifestations of the financial crisis, selecting the most suitable one case by case. However, the success of the ECB’s extraordinary measures must not make us forget the difficulties that monetary policy in the euro area has faced in recent years. The global financial crisis and the sovereign debt crisis have brought risks for the Eurosystem’s de facto independence that it would be naïve to ignore or underestimate. I will mention two of them. The first concerns financial autonomy and derives from the fact that the unconventional measures have expanded the size of the ECB’s balance sheet, though far less, at present, than those of the US Federal Reserve and the Bank of Japan. The quality of the securities held or accepted as collateral for bank refinancing has declined. In principle, monetary measures of macroeconomic stabilization can produce both losses and profits for the central bank adopting them. 22 But if a central bank made losses, its reputation would be endangered 23 and its ability to pursue its objectives could be put in doubt; ultimately, there could be mounting political pressure to reduce its independence. This is especially true in the case of the Eurosystem, which not only manages a currency without a state but finds itself facing a multiplicity of states which in these years of crisis have become more sensitive to what divides them rather than strengthening what unites them. The second, and far more important, risk consists precisely in the incompleteness of the European construction. Some are calling for amendments to the Treaty in order to expand the ECB’s mandate. 24 In particular, on the American example, it is urged that the objective of price stability be flanked by an explicit objective of equal status in terms of unemployment or employment levels; and that the ECB be allowed to purchase government securities directly at issue. Naturally it’s not up to me, a central banker, to say what objectives the political institutions should assign to the central bank. But these risk being false solutions to a false problem. Maintaining a moderate rate of growth in prices in the medium term like that indicated in the ECB’s objective equates to ensuring over the same time horizon that the economy operates at its potential, with physical and human capital fully utilized. Assigning the ECB a dual mandate would not imply any step forward. As for government securities purchases on the primary market, in reality this power, which can put the independence of any central bank in jeopardy, is granted to none of the central banks of the advanced countries, not even to those that have undertaken massive programmes of quantitative easing on the secondary Marco Casiraghi, Eugenio Gaiotti, Lisa Rodano and Alessandro Secchi (2013), “The impact of unconventional monetary policy on the Italian economy during the sovereign debt crisis”, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), No. 213. Milton Friedman, “The Case for Flexible Exchange Rates”, Essays in Positive Economics, University of Chicago Press, 1953, pp. 157–203. See, for example, Ulrich Bindseil, Andres Manzanares and Benedict Weller (2004), “The role of central bank capital revisited”, ECB Working Paper Series, No. 392. For a discussion of the objective of financial stability and the related implications for monetary policy, see Ignazio Visco (2014), “The challenges for central banks”, Quarterly Journal of Central Banking, Vol. XXV, No. 1. BIS central bankers’ speeches market, such as the US Federal Reserve and the Bank of England (which is subject to the constraints of the European Treaty). 25 The real problem is that the euro is a currency without a state. Economic theory and the experience of other monetary unions indicate that, regardless of the formal constraints, this greatly complicates life for those responsible for a single monetary policy, especially when it is a matter of taking unconventional measures that can have significant fiscal and redistributive repercussions. 26 In the absence of a single fiscal authority, some fear a redistribution “by stealth” among countries, not decided by the representative political bodies and carried out via the Eurosystem’s balance sheet. This fear, deeply felt today in the countries of northern Europe, has conditioned the use of the single monetary policy and, when it was a question of designing OMTs, imposed rigid conditionality, so as to prevent cases of “moral hazard” on the part of the countries in greatest fiscal difficulty and ultimately to impede or limit fiscal transfers between states. But what would have happened in all of Europe if in the summer of 2012 President Draghi had not given assurances that the ECB would do “whatever it takes” to preserve the euro? At the time of the euro’s creation, the advisability of accompanying the single currency with a fiscal union was the subject of long debate and there was no lack of contrary opinions, grounded, paradoxically, on the protection of the nascent ECB’s independence. Tommaso Padoa-Schioppa wrote in 1999: “The fact of not being accompanied by ‘his’ minister or ‘his’ government, may make the ECB President feel more independent and safe from unwelcome influences,” however, he hastened to add: “but in the view of the market, the international community and its citizens, “a currency without a state” constitutes an anomaly.” 27 The Treaty would protect the independence of the ECB well even if it faced a single fiscal authority. Indeed, in this case it would be easier to use monetary policy to respond to asymmetrical shocks, shocks hitting one or several countries of the area but not others. We have made important progress in this direction: the crisis management mechanisms, the reforms of fiscal and macroeconomic governance, and the still to be completed Banking Union. 28 The question remains open: How realistic is it today to imagine further progress towards a fiscal union among the countries that wanted to give themselves a single currency? Is gradual centralization of some public functions conceivable? 29 Or even just greater coordination of national budgetary policies that takes account of the situation of the euro area as a whole? 30 From Section 14 (Open-Market Operations”) of the Federal Reserve Act: “Notwithstanding any other provision of this chapter, any bonds, notes, or other obligations which are direct obligations of the United States or which are fully guaranteed by the United States as to the principal and interest may be bought and sold without regard to maturities but only in the open market.” Kevin H. O’Rourke and Alan M. Taylor (2013), “Cross of Euros”, Journal of Economic Perspectives, Vol. 27, No. 3, pp. 167–192. Tommaso Padoa-Schioppa (1999), “Moneta, Commercio, Istituzioni: esperienze e prospettive della costruzione europea”, Lecture delivered for the award of an honorary degree in International Trade and Currency Markets Economics, Trieste. See, for example, Ignazio Visco (2014), “The exit from the sovereign debt crisis: national policies, European reforms and monetary policy”, Lectio magistralis, Almo Collegio Borromeo, Pavia. Fabrizio Balassone, Sandro Momigliano, Marzia Romanelli and Pietro Tommasino, “Just around the corner? Pros, cons, and implementation issues of a fiscal union for the Euro area”, Banca d’Italia, mimeo. Interview of Governor Ignazio Visco with Federico Fubini, “Italia, hai poco tempo”, Repubblica, 7 September 2014. BIS central bankers’ speeches 5. Points of convergence and divergence in Europe today When the euro was created, the economies that adopted it were marked by differences and divergences. On the one hand was a group of less advanced, rapidly growing, countries with higher rates of inflation, and on the other, the core economies, with slower growth but higher levels of per capita income and basically stable prices. Italy was already in an anomalous situation of lower growth combined with higher inflation. In its first decade of existence the euro created the conditions for a virtuous, upward, convergence. The last six years of crisis have reversed this trend, in the direction of a “bad equilibrium”. The euro area is on the brink of deflation. In October consumer prices were just 0.4 per cent higher on average than a year earlier. Low inflation is a widespread phenomenon: in only 2 countries out of 18 is the inflation rate above 1 per cent. The slowdown in prices raises real interest rates, discouraging investment by firms and dampening demand for credit; it also increases the burden of debt service. 31 A falling rate of inflation verging on deflation has particularly serious repercussions for the euro area today: it hinders deleveraging in countries with high public or private debt; it slows the readjustment of relative prices between the various economies, and accordingly the recovery of competitiveness and the elimination of external imbalances where necessary. These price trends were partly unexpected. They were not just determined by the most volatile component (energy and food) but to a great extent by the weakness of demand. They risk disanchoring long-term inflation expectations. Already today expectations one and two years ahead, measured by swap contracts, are below 1 per cent; they do not approach 2 per cent until well past 2020. Expectations five and ten years ahead are for less low inflation, but still below 2 per cent. The central bank’s credibility in meeting the price stability objective is being called into question. In June and September the Governing Council of the ECB announced a series of new measures including the launch of targeted longer-term refinancing operations (TLTROs) and outright purchases of ABS and covered bonds. The measures are designed to enhance the functioning of the monetary policy transmission mechanism, support lending to the real economy and have a positive effect on the financial markets. As reiterated by President Draghi, the Governing Council is unanimous in its commitment to using other unconventional instruments within its mandate in order to cope effectively with the risks of an excessively long period of low inflation. It is important that we do not doubt the central bank’s ability to stimulate aggregate demand when this is needed to ensure price stability in the medium term; even less should we doubt the ECB’s independence and the strength of the institutional safeguards envisaged under the Treaty: those on the basis of which governments pledged to delegate the conduct of monetary policy and not interfere in it. There are two possible lines of reasoning in respect of today’s situation, one “economic” and one “political”. They ought to proceed in parallel but at times they diverge. The economic line of reasoning provides clear indications to those who are currently responsible for economic policy in the euro area. Almost all economists concur in identifying a serious shortfall in aggregate demand, caused by uncertainty and lack of confidence on the part of firms and households that every day must make investment and consumption decisions. Accordingly, they call for monetary and budgetary policies to be as expansionary See the box “The risks of low inflation for the financial stability of the euro area”, in Banca d’Italia Financial Stability Report No. 2, November 2014. BIS central bankers’ speeches as possible, as well as clear and credible, such as those adopted elsewhere in the advanced world: the United States, Japan and the United Kingdom. The political line of reasoning appears to indicate a different path. The sovereign debt crisis has roused a sleeping monster in Europe: distrust among nations. This is the most poisonous fruit of the crisis. This mistrust is undoubtedly based on objective truths. Northern countries in particular rebuke their Southern neighbours for reckless public expenditure over the years, the many wasted opportunities to reform their economies and make them competitive again. These views are widely held by public opinion in these countries, whose rulers – democratically elected political leaders – must take them into account. The result is a strong insistence on balanced public accounts: in the indebted countries so that they can be consolidated and in the financially sounder countries because they should set a good example. In all the euro-area countries opinion groups hostile to the euro and the European edifice are gaining traction. In the area’s current cyclical conditions this kind of political thinking, which evokes sound principles of social rigour and public morality, risks, however, contradicting the economic line of reasoning and producing long-lasting damage for the entire area. Monetary policy ought to be protected from this clash of economic and political reasoning by the same statute of independence attributed to the European System of Central Banks, which is responsible for its implementation. Until now this system has acted consistently. The internal debate within the Governing Council of the ECB that is occasionally made public is natural in any collegiate body. It is in the interest of all Europeans that its independence continue to be defended from within and seen favourably from without. However, the political line of reasoning cannot be ignored. The structural reforms in the euroarea countries that have lagged behind in competitiveness, Italy to start with, are vital for two reasons: the first is that they are the only way to unblock the jammed mechanisms of economic development; the second, equally important, is that they help to increase trust among nations. If the present diffidence should put down roots the entire European construction would be in peril. I would like to conclude with another enlightening reference to Carlo Azeglio Ciampi, when he delivered a speech celebrating the euro’s entry into circulation: “The single currency is above all the result of a desire for cohesion which, along with continuity and consistency of ideals, are the driving force of Europe. Cohesion is our greatest asset: it must however be willed, and it must have an identity, and a structure that is also institutional.” 32 Speech by the President of the Republic, Carlo Azeglio Ciampi, delivered on 26 November 2001. BIS central bankers’ speeches | bank of italy | 2,014 | 12 |
Remarks by Mr Fabio Panetta, Deputy Governor of the Bank of Italy, at a conference organized by the Fondazione Italianieuropei and the Foundation for European Progressive Studies, Rome, 6 February 2015. | Fabio Panetta: The European Banking and Capital Markets Unions – challenges and risks Remarks by Mr Fabio Panetta, Deputy Governor of the Bank of Italy, at a conference organized by the Fondazione Italianieuropei and the Foundation for European Progressive Studies, Rome, 6 February 2015. * 1. * * Introduction I would like to thank the Fondazione Italianieuropei and the Foundation for European Progressive Studies for inviting me to this conference. It is a pleasure to be here to discuss the opportunities and risks associated with the European Banking Union (BU) and Capital Markets Union (CMU). It is a very topical subject. In order to relaunch economic growth in the eurozone, the policies adopted at both national and European levels must be complemented by adequate financial support to the real economy. The institutional set up of the BU and the CMU is crucial to this end. I will first give an account of what has been achieved so far at the European level to foster the reintegration of the financial markets and spur economic growth in the Euro area. I will concentrate on the project for Banking Union (BU), arguing that its first stage, namely the Single Supervisory Mechanism (SSM) has been crucial to reaffirm the commitment of all eurozone member countries to the single currency and to foster financial integration. This means that the SSM has already contributed to the sustainable growth of output and employment in Europe, even if that contribution is hard to pinpoint or measure. Second, I will offer a reflection on the further steps we have to take in order to ensure that the project delivers on its stated objectives. Finally, I will touch upon some of the Capital Markets Union initiatives, concentrating on those designed to increase access to finance for small and medium-sized enterprises. 2. Banking Union: the main achievements We must not underestimate what has already been accomplished by the BU project. This thorough overhaul of the euro area supervisory architecture took place in – indeed, was motivated by – an environment marked by unsatisfactory economic growth, increasing perceptions of sovereign risk and mounting doubts on the very survival of the euro. The BU project has already helped the stabilization efforts in the Eurozone, which is a prerequisite for economic growth. First, it gave an important signal of the willingness of the member countries to forge ahead with unification. In itself, this provided a potent antidote to the sovereign debt crisis, whose key determinant had been lack of confidence in the single currency project. Second, common supervision and a centralized resolution authority lay the basis for financial stability. Banking Union, together with other national and European policies – in particular, the monetary policy measures recently decided by the Governing Council of the ECB – is already contributing to the normalization in credit conditions for firms and households. The comprehensive assessment of the balance sheets of the largest euro area banks, which preceded the launch of the (SSM), enhanced transparency and dispelled doubts about the banks’ resilience. Further progress is expected as the SSM brings harmonization of supervisory and business practices, reducing investors’ perception of risks. Although complete normalization in credit conditions will likely require definitive exit from the crisis and a return to stable economic growth, signs of gradual improvement can already be discerned in the surveys conducted by the Eurosystem and in other indicators. BIS central bankers’ speeches Banking Union has imparted a strong impulse to the efficiency of the financial system by fostering competition across euro area countries. Consider for example the recent decree on the governance of the cooperative banks in Italy. The initiative is the product of a good many years of reflection on the shortcomings of the cooperative structure for listed or very large banks; at the same time, it can be read as part of a broader reform effort to bring the Italian economy up to the best European standards of efficiency. 3. How to consolidate a promising start The important steps already taken need to be followed by further progress, on several fronts. Since the list would be long, I shall mention just one general issue and two specific ones. The overarching issue: further progress towards European integration is essential. We should not forget that the current crisis was provoked, in part, precisely by lack of progress in European integration following the adoption of the single monetary policy. The BU project has gotten the process started again, helping to defuse the crisis. But we must not make the same mistake twice; the integration process cannot be allowed to stall again. Progress in this direction is particularly difficult at present, because national centrifugal forces seem strong. They are visible in various forms: growing support for anti-euro or euro-skeptical political parties in several countries, for one, and the difficulties encountered by European and Eurozone institutions in discussing issues from an area-wide perspective, for another. National interests and perspectives are strong. Take, for instance, the distinction between core and periphery, which has become standard in many discussions and official publications. If unification is to advance, we must reinforce mutual trust at the international level. This must be achieved over time, through consistent behavior on the part of all parties and recognizing that it is in the interest of every member state to factor in the need to reduce negative spillovers from one economy to the others. If we succeed, it will gradually become clear that there is no conflict between European financial integration and financial stability; indeed, that by favoring the cross-border diversification of risks, financial integration will foster financial stability. Let me now turn to some specific issues. Micro- versus Macroprudential policies. Throughout 2014 and since the launch of the SSM, the European supervisory authorities have focused mainly on the capital position of banks. This emphasis on strong capitalization was necessary to restore confidence. Now that the comprehensive assessment has shown that the European banking system is solid, it is essential to avoid inducing pro-cyclical behavior by banks, curtailing lending to the economy. Let me elaborate on this issue. Any bank, taken individually, may have an incentive to strengthen its capital adequacy by curtailing lending. This does not have strong counterindications if other banks have incentives to expand lending. But if all the banks seek to deleverage at the same time, this could trigger a credit crunch, with adverse repercussions on the economy and ultimately on the banking system itself. The crisis drove this simple lesson in externalities home emphatically, prompting the creation of macroprudential authorities in most countries. 1 And as we know, the incentives of micro- and macroprudential authorities are aligned during economic expansions (both policies should be tightened, to strengthen the resilience of single banks and to “lean against the wind” of an aggregate credit boom). However, they tend to diverge during downturns, when, as I just now observed, the macroprudential authority should be wary of imposing stiffer capital requirements. See the de Larosière report, 2009. BIS central bankers’ speeches The present state of the economy in the Eurozone offers a textbook case of the potential tension between micro- and macroprudential policies. There is broad agreement (eg within the ESRB) that macro risks – low nominal growth in particular – are among the more serious threats to financial stability. In the Eurozone credit growth is negative, and the credit/GDP gap (the main indicator set by the Basel rules to steer the countercyclical capital buffer) is amply negative in most countries. Fully aware that relaunching nominal economic growth in the Eurozone is the paramount objective, the ECB has embarked on a program of quantitative easing. In this environment, macroprudential policy needs to lean decisively against the wind and act to rekindle credit and economic growth. But in practice it is not doing so. Indeed, most recent macroprudential actions at national level have further tightened capital requirements, in response to national problems. Coupled with the ongoing micro-level tightening, these measures could ultimately aggravate the risks of persistently low nominal growth. There are certainly good reasons, on which I shall not elaborate here, for leaving area-wide macroprudential instruments on hold. At the same time, since under the Regulation the SSM has both micro- and macroprudential responsibilities, I believe that reflection on this issue is warranted. The complexity of the European system of financial supervision is extraordinary. This complexity follows from two main factors. First, there are a large number of actors on the stage – at both national and supranational levels, with both micro- and macro-prudential objectives – and in interaction with one another. Legislators, perfectly well aware that the new set of rules that originated the system may need some fine tuning, incorporated the deadlines of a revision process in the rules themselves. Time and experience will tell just how much room there is for simplification. Second, EU member countries are still characterized by different accounting and legal regimes. Convergence is necessary for company, insolvency and taxation law in particular, but a gradual approach will be inevitable. Meanwhile, an effort by all stakeholders will be necessary to get the system to work effectively and to ensure a level playing field. Heterogeneity is found in the area of supervision as well, but here I am confident that the SSM will bring relatively swift convergence in supervisory practices. My own very preliminary assessment of the functioning of the SSM is positive. The progress achieved in such a short time has been amazing. Nonetheless, we are still at the very first stages, and adjustments may well be necessary. We need to avoid the risks of inefficiency that stem from the complexity of the machinery. A huge number of issues – and of related decisions – are brought to the attention of the Supervisory Board; this threatens to deflect attention from proper reflection on the more important issues. I am sure that we shall be able to flexibly adapt the framework as needs arise. 4. The Capital Markets Union That European firms rely too heavily on banks for external funds has been known for decades, but the crisis has now thrown the dangers of this model into sharp relief, highlighting the need to enhance the role of market funding. The Capital Markets Union (CMU) initiative is directed to this ambitious goal. Further development of non-bank sources of funding seems possible, if we compare the European to the more market-oriented economies. European businesses get the bulk of their financing from banks, while in the US market-based financing is much more highly developed, even for SMEs. The Commission has set an ambitious agenda in this field, with the aim of channeling funds to Europe’s businesses, particularly SMEs. The agenda includes an effort to revitalize the market for sound (simple) securitizations (which requires work at EU level to design a consistent framework and avoid regulatory arbitrage); harmonization of the market for covered bonds, building on the successful experiences of some European countries in order to generalize best practices; stimulation of crowd-funding initiatives, gradually eliminating BIS central bankers’ speeches significant national differences in legislation and supervisory approaches; enhancement of the small-scale corporate bond markets via mini-bonds; and endorsement of the efforts to identify a common framework for private placement transactions. 2 The Commission is also working to improve and standardize information on firms, in particular SMEs, and the related disclosure and transparency requirements. The scarcity of such comparable information is a deterrent to cross-border financing, which cuts across the different market segments and types of instruments. In the medium to long term, the CMU can bring significant benefits: broadening and diversifying the EU financial market, thus improving its resilience, efficiency and competitiveness; eliciting greater long-term financing; and enhancing the supply of equity, to encourage euro-area firms to rely less on bank credit and to rebalance their capital structure. In the short term, the efforts to enhance market-based sources of funding are part of the policy response to pronounced bank deleveraging within the EU and the attendant anemic credit growth. Some of the items on the Commission’s agenda may be crucial to this end. Indeed, bank deleveraging itself, together with the search for higher yields by institutional investors, may be a powerful catalyst for the development of these alternative sources of external funds. * * * To conclude, a lot has been achieved but a lot remains to be done in order to create a stable and efficient financial market in the Eurozone. In order to succeed, we must avoid piecemeal policies and work in order to reinforce mutual trust at the international level. A comprehensive view of all the trade-offs entailed in the various policy measures is required in order to safeguard the stability of individual financial institutions, with the key objective of ensuring the availability of resources for investment and economic growth. This effort is being undertaken by the Pan-European Private Placement Working Group, led by the International Capital Market Association. The European Council has welcomed these initiatives and invited the Commission to take stock of their outcome and consider at the same time how policy actions could play a supportive role in the development of a sustainable private placement market in the EU. BIS central bankers’ speeches | bank of italy | 2,015 | 2 |
Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the 21st ASSIOM (The Financial Markets Association of Italy) FOREX Congress, Milan, 7 February 2015. | Ignazio Visco: Economic developments in the euro area and Italy, monetary policy, credit and banks Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the 21st ASSIOM (The Financial Markets Association of Italy) FOREX Congress, Milan, 7 February 2015. * * * The positive signs emerging from the global economy are still accompanied by marked uncertainty. While growth has accelerated in the United States, it remains weak in Japan and is slowing in China and in other emerging economies; in Russia it is contracting rapidly. The slump in oil prices may bolster economic activity in the advanced countries but it is also the result of weak demand; it must be prevented from entrenching expectations of deflation. Financial conditions are favourable, but market volatility is on the rise. Economic developments in the euro area and Italy The euro area is struggling to re-establish satisfactory rates of growth and unemployment is still very high. While consumption has picked up somewhat, domestic demand has been held down by investment, which contracted in the second and third quarters of 2014. The difficulties are widespread: average area-wide GDP growth is no higher than the modest rate recorded for the group of countries directly hit by the sovereign debt crisis. After a long series of unexpected drops in consumer price inflation, in December the twelvemonth variation was negative in eleven countries and, for the first time since October 2009, in the euro area as a whole. Nowhere did inflation top 1 per cent. Preliminary estimates indicate that in January consumer prices fell by 0.6 per cent, and by 0.4 per cent in Italy; this does not just reflect the drop in energy prices, as even without this component inflation has reached an unprecedented low of under 0.5 per cent in the euro area. Medium- and longterm inflation expectations have been affected and this downward shift must be countered with firmness. In the first week of February the expectations implied by five-year inflation swaps were still 0.7 per cent and those for the five to ten year horizon were 1.6 per cent. Italy is among the countries that are struggling hardest to make a start on the road to recovery. GDP has been declining almost without a break for three years and is expected to show no increase in the last quarter of 2014, mainly owing to the further contraction in investment, which is more than a quarter below the level of 2007. The latest data point to some encouraging developments for both the euro area and Italy. The Bank of Italy’s €-coin indicator, which tracks underlying trends for the euro-area economy, rose in December and January after falling steadily from May to November 2014. In December the unemployment rate fell marginally in the euro area (by 0.1 percentage points to 11.4 per cent) and slightly more (by 0.4 points to 12.9 per cent) in Italy, where the number of persons in employment rose by over 90,000 in the month. Household and business confidence has been picking up since the beginning of the year. These developments have likely been affected by the drop in oil prices and the changes in interest and exchange rates caused by expectations of expansionary monetary policy measures. A revival of capital expenditure is essential in order to consolidate growth. In many countries, especially Italy, the uncertain economic outlook has led firms to take a “wait and see” approach. In the December surveys conducted by the Bank of Italy almost half of the firms still expected their expenditure on investment to remain virtually unchanged in 2015. Signs of a possible resumption have emerged only in some branches of manufacturing. A suitable policy mix must contribute to reversing the trend in investment and strengthening consumption. The new monetary policy measures are designed to defuse the risk of a negative spiral of deflation and economic stagnation. Budget policies in the euro-area countries, which have been persistently restrictive, can now be better adapted to cyclical BIS central bankers’ speeches conditions. For demand stimulus to generate lasting growth, measures must be taken to reform the economy’s capacity to respond to structural changes. Monetary policy On 22 January the ECB Governing Council announced a programme of purchases of bonds issued by euro-area public authorities and European institutions to supplement the existing ones for covered bonds and asset-backed securities. It is a far-reaching measure, broader than markets expected, to be rolled out immediately, and open ended. The Eurosystem will buy €60 billion worth of bonds a month from March this year until September 2016, for a total of €1,140 billion. The programme will in any event continue to run until a lasting change is achieved, with the trend of inflation returning close to 2 per cent. Intervention by the national central banks (NCBs) will be proportionate to their shares in the ECB’s capital; the Bank of Italy’s purchases of Italian government securities could be in the region of €130 billion. The Council viewed the expanded asset purchase programme as a legitimate tool of monetary policy and voted by a large majority to deploy it immediately. Equal sharing of the attached risks would have been more consistent with the singleness of monetary policy. The decision to let the balance sheets of the single NCBs carry the risk of losses on government bond purchases reflects a concern within the Governing Council that in the present institutional framework such a monetary policy measure might lead to transfers of resources between countries without the approval of the competent bodies. In any case, the more successful the programme proves to be in curtailing the macroeconomic risks faced by the euro-area countries, the more it will also reduce the risks to the NCBs’ balance sheets. Asset purchases can transmit effects to the economy through a variety of channels. They exert downward pressure on medium- to long-term interest rates, directly for the assets included in the programme, and indirectly for all the others through portfolio reallocations. They encourage bank credit by making it relatively more profitable than buying government securities and by reducing the cost of funding. They sustain inflation expectations and confidence. They help to ensure that changes in the exchange rate are consistent with cyclical developments: although the euro exchange rate is not a monetary policy objective, any variations linked to the monetary conditions in the different currency areas are an important component of the transmission mechanism. The effects on financial asset prices and, looking ahead, on real asset prices can stimulate consumption. The risk that the programme could lead to excessive price increases for real and financial assets, such as to threaten financial stability, is limited in the current climate. There are no indications that any widespread imbalances are forming in the euro area at the moment: credit is still languishing, assets do not appear to be generally overpriced; overall the propensity to take risks is still low. Should tensions emerge in local market segments, they would be countered by the national authorities with targeted macroprudential measures (such as those already introduced in some countries) without altering the expansionary stance of monetary policy. The purchase of government securities does not make the introduction of reforms to increase the growth potential of the euro-area countries any less necessary or likely. Indeed, it can foster them by improving the macroeconomic outlook and reducing its uncertainty. The effects of the programme have already been seen in part on the financial and currency markets. Lower interest rates and the depreciation of the exchange rate could bring euroarea inflation to levels more consistent with the definition of price stability towards the end of 2016. By acting on demand, they will also help to raise GDP. For Italy, we consider that the effect on GDP could exceed 1 percentage point in 2015–16, other things being equal. About half of this effect was already factored into the forecasts published in the Economic Bulletin of 16 January, which took account of the trends observed following the communication of November’s Governing Council on the start of the preliminary technical work for the BIS central bankers’ speeches programme. The further variations in the interest and exchange rates deriving from the new measures could lead to higher GDP growth, currently estimated at more than 0.5 per cent this year and more than 1.5 per cent in 2016. These effects could be joined by those connected to the other transmission channels, which are more difficult to quantify but also potentially important. The forecasts remain, however, subject to a high degree of uncertainty, mostly connected with developments in geopolitical conditions and their impact on world trade, the price of oil and the exchange rates themselves. Other policies Monetary stimulus is not in itself enough to strengthen the signs of the recovery. Without parallel budgetary action the effects on demand may be limited; they will fade in the medium term if there is no structural intervention on the economy’s growth potential, using instruments capable of increasing both productivity and employment, creating new income and new demand. The overall stance of fiscal policies in the euro-area countries was still restrictive in 2013, basically neutral in 2014, and is expected to remain the same in 2015 despite the unfavourable economic climate. When the crisis was at its height, the budgetary adjustments introduced in a number of countries bolstered confidence among the member states and reassured the markets. Thanks to these corrections, as well as to the strengthening of Europe’s governance and the start of structural reforms, today there is scope for measures to support demand. Political and financial tensions can still affect market stability in the area, but the risks of contagion are fewer than in the recent past. The investment plan announced by the President of the European Commission at the end of last year marks the first attempt to organize a coordinated response at European level. The plan can be implemented rapidly, overcoming any difficulties in establishing new institutions and procedures and using all the sources of funding available. The Commission’s recent communication on flexibility in applying budgetary rules is another important signal, mainly with regard to the calibration of policies based on the output gap and the treatment of national contributions to the European investment fund. The Commission has explained that the latter will not affect the evaluation of countries’ structural budget position nor – within certain limits – decisions relating to the excessive deficit procedure. The Italian Government, while confirming its commitment to continue to adjust the public finances, has adapted the pace to the economic outlook. The structural reform programme undertaken in recent years must proceed, in particular as regards implementing decisions already taken. All in all, the measures introduced so far go in the right direction. Lastly – in the wake of the 2012 reform to reduce the dualism in Italy’s labour market – the first two implementing decrees of the Jobs Act have extended the protection provided by unemployment benefits and reduced the costs of procedures to terminate employment contracts and the uncertainty over their final outcome. The enabling law establishes that they shall be accompanied by an appropriate revision of active labour market policies. Improving the efficiency of the public administration will increase the competitiveness of Italy’s productive system, which is a prerequisite for the effectiveness of all the other reforms. Measures have recently been adopted to promote public employee mobility. A draft enabling law for broader reform, centred on increased transparency and simplification, is being discussed in Parliament. The success of the reform will depend on how the good principles underpinning the law are implemented in practice. By international standards Italy’s stock of human capital is limited and inadequate for an advanced country. By developing the right skills and capabilities through better education and training, the country could find its way back to a higher growth path. Corruption and the BIS central bankers’ speeches infiltration of the economy and society by organized crime remain unacceptably widespread. Guaranteeing observance of the law, partly through more effective administration of justice, enables the productive economy to function properly, encourages entrepreneurship, and attracts human and financial resources to the country. Credit and banks Improvements in credit market conditions fostered by the new monetary policy measures must accompany a revival of investment. Although the trend in business lending is improving it is still negative, above all owing to weak demand but also because of residual supply-side strains. Banks’ caution in lending is mainly due to the high default risk generated by the protracted recession. In 2014 the flow of new bad debts decreased steadily from the peaks of mid-2013 but it remains nonetheless high; according to the latest figures, in the third quarter the annual bad debt rate was around 2.5 per cent for total lending and 4.0 per cent for loans to firms. The new monetary policy measures, which reduce macroeconomic risk, should also have beneficial effects on credit risk. At the end of September bad debts accounted for 10.6 per cent of the total customer loans of the leading banking groups while total non-performing loans amounted to 18.3 per cent. The still high proportion of the latter is partly due to the absence of a secondary market for these assets in Italy, as well as to the slow process of credit recovery. To date, transfers of these assets have been possible in just a few cases and at very low prices, incorporating not only normal management costs and the risks of the underlying assets, but also the uncertain economic outlook for the country. Banks must liquidate their non-performing loans in order to raise funds to finance the real economy. Direct state intervention – within a framework whereby, in accordance with European rules on competition, banks participate fully in the costs of the operation and public support is suitably remunerated – could be used not to remedy excessive risk taking by single banks, but to respond to the deterioration in loan quality caused by the severity and length of the recession and to the need to ensure an adequate flow of financing to the economy. Appropriate tax relief or state guarantees on assets backed by bad debts would smooth the way for the creation of a private market in non-performing loans. With the conclusion of the comprehensive assessment of the balance sheets of the largest euro-area banks, regular supervisory activity under the single supervisory mechanism has commenced. All the significant banks supervised directly by the ECB, with the assistance of the national authorities, have been notified of capital adequacy targets based on an analysis of their respective risk profiles. This practice, which is specifically envisaged under the rules of the second pillar of the Basel capital accord, is similar to the one that the Bank of Italy followed before the single supervisory mechanism and that it continues to use for the institutions it supervises directly. The banks for which the assessment identified capital shortfalls have been assigned targets that are largely in line with the plans they presented following the exercise. In recent years the need to observe more stringent capital adequacy requirements has affected the banks’ propensity to lend during a cyclical downturn. Additional requirements for capital increases must be carefully calibrated so as not to undermine the signs of economic recovery. More generally, in the new context of Banking Union, a clear and stable supervisory review process in the spirit of Basel rules will make it easier for banks to draw up long-term plans, improve market transparency, and limit the potential pro-cyclical effects. In the coming months single supervision will also focus on the sustainability of banks’ business models. Lighter cost structures and business models that can adapt promptly to new technology will help banks cope with change more effectively. Italy’s banks have made progress in recent years, but there is still room for improvement. A review of production and distribution processes will lead to efficiency gains and cost savings. Profit levels could be raised through greater diversification of revenues, which could include helping firms to BIS central bankers’ speeches access markets directly. There is scope for mergers and acquisitions designed to rationalize corporate structures and modernize production and distribution processes. Appropriate corporate governance structures capable of increasing firms’ resilience and competitiveness remain essential. The Government recently announced a reform of Italy’s cooperative banks that responds to needs identified long ago – by us, by the International Monetary Fund and by the European Commission – and now made more pressing by the transition to single banking supervision. The reform would require the biggest cooperative banks to approve their transformation into joint stock companies, an ownership structure that gives them increased access to capital markets. Broader participation by shareholders in general meetings would reduce the risk of power becoming concentrated in the hands of organized minority shareholder groups. There would be a greater incentive to monitor the conduct of management. The cooperative bank model could still be used by small and medium-sized intermediaries, thereby preserving the cooperative spirit of those local communities to which it is well-suited. For these intermediaries too, the reform aims to strengthen several aspects of governance and to increase the incentives to invest in their capital. In the mutual banking sector capital strengthening requirements can be hindered by these banks’ special legal form. Weaknesses stem from their at times extremely small scale, with implications for costs and innovation, and from excessive concentration of credit risks. Greater consolidation, favouring the creation of groups, can improve operational efficiency and recourse to the market for aligning capital to risks. These objectives can be achieved without sacrificing the mutualistic traits typical of the cooperative model. The launch of the single supervisory mechanism was accompanied by that of the single mechanism for resolving bank crises. European legislation in this area has already been drawn up. Italy is behind in the transposition of the Bank Recovery and Resolution Directive (BRRD). The deadline for its adoption was the end of 2014, but Parliament has yet to approve the enabling law and establish the national resolution authority. * * * The monetary policy measures taken during the crisis, including the latest ones, the progress made in European economic governance, and the efforts of national governments have reduced the uncertainty that in recent years has weighed so heavily on economic activity in the euro area. This progress must not be put at risk but rather reinforced by laying the institutional foundations needed to shelter the stability of monetary union once and for all from turbulence originating at local level and to guarantee lasting prospects for growth. To strengthen monetary union permanently further steps must be taken towards political union, but the road ahead will be neither short nor smooth. In the immediate future, mechanisms can be identified to fill the gaps of an incomplete Union by bringing to a satisfactory conclusion the reforms already launched and exploiting fully the instruments to hand. Banking Union can be, as originally intended, an important factor of stability for the euro area so long as we succeed in striking the right balance between the need to safeguard the stability of banks and that of enabling them to support the economy. Exploiting fully the flexibility allowed under the fiscal rules to finance reforms to correct structural weaknesses should help to prevent crises rather than merely controlling and managing their consequences. Over the longer term, a number of other areas for common action may also be identified, with a gradual, circumscribed pooling of financial resources. In our country efforts to make the economic environment more business friendly must be pursued unstintingly. Any lasting recovery of investment requires savings to flow to firms not just through a fresh expansion of bank credit but also via increased direct access to capital markets, not confined to the largest firms. The most innovative sectors and those best able to create new jobs stand to benefit as a result. BIS central bankers’ speeches | bank of italy | 2,015 | 2 |
Speech (lectio magistralis) by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy, at the Almo Collegio Borromeo, Pavia, 17 March 2015. | Salvatore Rossi: Knowledge, innovation and relaunching the economy Speech (lectio magistralis) by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy, at the Almo Collegio Borromeo, Pavia, 17 March 2015. * * * I wish to thank the Almo Collegio Borromeo, its Rector and the President of the European Pole of Excellence Professor Dario Velo for doing me the honour of inviting me to give a lectio magistralis within these walls, imbued with history and science, and before such an accomplished audience. I also thank the President of the Collegio’s Board of Directors, Vitaliano Borromeo, for the very kind words with which he outlined my intellectual interests and professional career. The title we chose for the lesson brings together three topics – knowledge, innovation, and relaunching the economy – which constitute as many decisive challenges for our country: decisive for our future and for our role in the world. I have dedicated much thought to these topics over the years, expressing my reflections time and again in writings and public addresses. Today, I would like to draw some of the threads together, retracing and connecting up those reflections, and advancing some policy proposals. 1 I will discuss the three topics of the title in reverse order. I begin, inductively, with the need to relaunch the Italian economy and set it on a stable path of efficiency, competitiveness, and progress. This, I will explain, depends on the productive system’s ability to innovate continuously both what and how it produces. I will then work back to the basis of this ability – knowledge and competence – and how and where it can be “produced”. Relaunching the economy The Seven Years’ War – Today, the Italian economy finds itself in the aftermath of a war, as it were. Not, fortunately for us, an old-style war with bloodshed and destruction, but one of those modern, virtual wars, in which factories, offices and jobs are obliterated with the click of a mouse. We now produce almost a tenth less than we did seven years ago: in manufacturing, 17 per cent less; in construction, more than 30 per cent. It is estimated that manufacturing lost one sixth of its productive capacity in this period. 2 Net job destruction reached almost one million. Last year, Italian firms invested overall a third less than seven years earlier. As a whole, households spent 8 per cent less in real terms. Exports have struggled to stay on an even keel. I base this process on some of my recent speeches, from which I quote extensively: Artigiani o scienziati? Capitale umano e crescita economica, address to the International Symposium of University Professors “Giovani, formazione, università”, Rome, 21 June 2012; Alle radici dello sviluppo: demografia, istituzioni, th politica, 5 Onorato Castellino Lecture, Moncalieri, 29 November 2013; L’innovazione nelle imprese italiane, address at the Conference “I giovani e il difficile futuro della ricerca scientifica in Italia: Riflessioni a 50 anni dalla nascita della Fondazione Luigi Einaudi onlus”, Turin, 15 October 2014; Building the Future of the Italian Economy, address at the ceremony for the opening of the academic year 2014–2015, University of Udine, 19 January 2015. All the texts are available at www.bancaditalia.it/pubblicazioni/interventi-direttorio. L. Monteforte and G. Zevi (2014), “An inquiry on manufacturing capacity in Italy after the double-dip recession”, Gli effetti della crisis sul potenziale produttivo e sulla spesa delle famiglie in Italia, Seminari e convegni, No. 18, Banca d’Italia (http://www.bancaditalia.it/pubblicazioni/collana-seminari-convegni/20140018/Effetti-crisi-n-18.pdf). BIS central bankers’ speeches The global financial crisis of 2007–08, followed by the European sovereign debt crisis of 2010–11, inflicted far greater damage on Italy’s economy than on those of the other main advanced countries. “Why?” we must ask ourselves. The first point to make is that the aggregate data hide significant disparities. The differences between firms and between households have increased. Italy’s productive system, taken to include both industry and non-financial market services, is distributed in lopsided fashion along a line determined by size. 3 The 25,000 firms located above the 50-employee line produce almost half the total value added of the sectors considered and use almost half the payroll employees: more than 5 million workers out of a total of 11 million. Some 4.3 million small firms employ, in addition to around 6 million permanent staff, 4 million self-employed workers, the very owners of the businesses. Thus, per capita value added – that is to say, productivity – is low among small firms. Labour costs are also lower, but with a much narrower gap, so that small firms are generally less competitive than medium-to-large ones. As is to be expected, almost all manufactures exports are by medium-to-large firms. The size aspect is also key in shaping investment decisions. Large or very large firms continued to increase their stock of capital during the recession years. Many small firms, on the other hand, stopped investing, except in replacement assets for “survival”. Then, in the last two years, numerous medium-size exporting firms that are both profitable and liquid have also put their investment plans on hold until the global and domestic economic outlook becomes clearer. Viewed as a whole, the contraction in consumption in these seven years was atypical with respect to past negative phases of the economic cycle. Normally, one would expect consumers to try to maintain existing standards of living during a recession despite the drop in disposable income, assuming it to be temporary. This time the opposite happened: people tightened their belts more than the drop in income warranted. Thus, they assumed that drop to be permanent, and indeed that it would continue to worsen, and so they judged it wise to increase precautionary savings. 4 Did all Italian households take this line? No, there was a split between them, and this time the dividing line was generational. Living standards, in terms of quantities consumed and decisions what to consume, fell sharply among the youngest households, and not only those whose head was unemployed: young payroll workers suffered from the widespread precariousness of jobs, while the self-employed, especially those at the head of small and micro businesses, had to use their own income to solve the firm’s problems. Instead, the higher income brackets, which include few young households, increased their spending on luxury goods. 5 Getting started again and moving forwards – Is the damage done by the Seven Years’ War permanent? Well, we have certainly slipped some way down as far as economic conditions are concerned and we cannot get back what we have lost. But we can make a new start, albeit beginning from a lower position than the one we occupied seven years ago. We might even progress at a faster pace than we did before we were overtaken by the double-dip recession. In what follows I quote data taken from Istat (2014), Struttura e competitività del sistema delle imprese industriali e dei servizi, anno 2012, Report of 27 November 2014. M.L. Rodano and C. Rondinelli (2014), “The Italian household consumption: a comparison among recessions”, Gli effetti della crisi sul potenziale produttivo e sulla spesa delle famiglie in Italia, Seminari e convegni, No. 18, Banca d’Italia (http://bancaditalia.it/pubblicazioni/collana-seminari-convegni/2014-0018/Effetti-crisis-n-18.pdf). C. Rondinelli, A. Bassanetti and F. Scoccianti (2014), “On the structure of Italian households” consumption patterns during the recent crises’, Gli effetti della crisi sul potenziale produttivo e sulla spesa delle famiglie in Italia, Seminari e convegni, No. 18, Banca d’Italia (http://bancaditalia.it/pubblicazioni/collana-seminariconvegni/2014-0018/Effetti-crisis-n-18.pdf). BIS central bankers’ speeches All the premises are there. Prices for energy, on which we depend so heavily, are low again. The highly accommodative stance of monetary policy in the euro area has provided our firms with a favourable exchange rate, on both foreign and domestic markets, and unprecedentedly low interest rates. There is an increasingly strong drive to reform the country’s economic and social fabric, which has elicited international approval even though it has met with internal division and resistance. In the latest scenarios prepared by several forecasters, including the Bank of Italy, output will grow modestly this year, and more the next. It is a cautious and uncertain new start, however, and it needs encouragement. Many firms that could revive their investment plans hesitate to do so. If they decide in favour, it will lead to an increase in employment, and the renewed confidence will spread to households as well. Trusting that the recovery will gain strength, we must ask ourselves again why these years of crisis have been so much harder for us than for the countries against which we measure ourselves. Our analysis will take us to the root of the structural problem that has beset the Italian economy for several decades. Between the last two recessions – that of 1992–93 and that of 2008–14 – something fundamental has taken place around our economy: the dominant world technology has changed, speeding up the pace of market globalization; the euro has been created. Most of Italy’s productive system was slow to take up the new information and communication technologies as an opportunity to improve efficiency, as other national systems instead did. 6 It failed to grasp immediately that its addiction to devaluations of the lira, with their short-term competitive gains but lasting inflationary consequences, had to become a thing of the past and that competitiveness needed to be structurally reinforced. In reality, the productive system could do neither because the form and structure it had inherited were unsuited, being dominated by small firms, adverse to growth even when faced with a concrete opportunity to expand in size. That situation was the legacy of a familycentric culture and even more so of a political and institutional milieu hostile to a free market and entrepreneurship. Italy has the largest productivity gap between small and medium-tolarge firms of all the main European countries. Firms everywhere are born small, but then they either die or grow up quickly. In Italy, if they don’t die, they remain forever in the limbo of stunted growth. Steps must be taken to change this situation because it conflicts with the need for innovative capacity, which I will now briefly discuss. Innovation The distinctive trait of modern times is constant innovation. A century ago, someone could easily spend an entire lifetime producing or trading the same goods or services with immutable characteristics, for which customers’ demand rose and fell only with their changing financial situation. Today, no goods or services stay the same except for a very short time, after which they must be renewed, in substance or at least in presentation, if they are not to disappear from the market. Consumers want to be continually surprised by something they didn’t know existed. Producer goods too must change in order to accommodate or power innovation in final consumer goods. Banca d’Italia (2009), “Rapporto sulle tendenze del sistema produttivo italiano” (ed. M. Brandolini and M. Bugamelli), Questioni di Economia e Finanza (Occasional Papers), No. 45; S. Rossi, ed. (2003), La Nuova Economia. I fatti dietro il mito, Il Mulino, Bologna. BIS central bankers’ speeches The very distinction between manufacturing and services is becoming blurred. More and more commonly a manufacture is just a container for services, without which it would be valueless. It is the services that determine development in the quality of the good. Smartphones are the most obvious example. Today’s manufactures/services are produced in ways that are themselves new. The digital revolution has broken down vertically integrated production systems into single tasks – logistics, accounting, component production, maintenance, marketing and so on – that can be outsourced anywhere in the world. Long supply chains have been formed, or global value chains, under the direction of a lead firm but involving dozens of subcontractors, often located in emerging countries where low labour costs more than offset the costs of coordination and transportation. 7 World trade has been revolutionized, both in geographical extent and in its very nature. 8 Finally, robotics is advancing by leaps and bounds. Existing technologies still leave enormous untapped potential for innovation in production methods; 9 we are on the eve of an era of practically total robotization of manufacturing, with far-reaching repercussions for the labour market in both the emerging and the advanced countries. 10 Save for some niches of super high-end craftsmanship, making something “by hand”, which is the origin of the word manu-facturing, will come to mean not operating a lathe but handling a mouse or a joystick to activate servomechanisms and 3-D printers. And given this trend towards the automation of material production, global value chains themselves could shorten and relocate as the cost advantage of emerging countries is eroded. Yet counterforces are also at play. Manufactures – or “robofactures” – will continue to be central to our life as containers of services. The conception and, at least in part, the production of these services will of course have to be done by flesh-and-blood workers. These workers will have to be specially educated and trained – a point to which I will return further on. Coming back to the present, Italian firms as a group have much less innovative capacity than those of other advanced economies. The split that characterizes the corporate system is also apparent in terms of capacity for innovation. 11 This term “innovation” must be understood in the broad sense. It involves product characteristics and the production process, of course, but also marketing practices, corporate organization, and participation in global supply and value chains. Confining our attention to product and process innovation alone, a survey conducted at the very onset of the global crisis found that only 40 per cent of Italian firms were engaged in such innovation, far below the 64 per cent reported for German firms. 12 And we also know that where explicit R&D activity is lacking, the results of innovation are not as good: firms are R. Baldwin and J. Lopez-Gonzales (2013), “Supply-Chain Trade: A Portrait of Global Patterns and Several Testable Hypotheses,” NBER Working Papers, No. 18957; A. Accetturo, A. Giunta and S. Rossi (2011), “Italian firms between crisis and the new globalization,” Questioni di Economia e Finanza (Occasional Papers), No. 86, Banca d’Italia. B. Hoeckman (2014), Supply Chains, Mega-Regionalism and Multilateralism. A Road Map for the WTO, CEPR Press. E. Brynjolfsson and A. McAfee (2014), The Second Machine Age: Work, Progress, and Prosperity in a Time of Brilliant Technologies, W.W. Norton & Co. I. Visco (2014), “Perché i tempi stanno cambiando …”, Lettura del Mulino, Bologna, 18 October. M. Bugamelli, L. Cannari, F. Lotti and S. Magri (2012), “The innovation gap of Italy’s productive system: roots and possible solutions”, Questioni di Economia e Finanza (Occasional Papers), No. 121, Banca d’Italia; B.H. Hall, F. Lotti and J. Mairesse (2013), “Evidence on the impact of R&D and ICT investment on innovation and productivity in Italian firms”, Economics of Innovation and New Technology, 22(3). Eurostat (2010), Community Innovation Survey 2008. BIS central bankers’ speeches less capable of patenting inventions and industrial designs, registering brands and protecting intellectual property rights. The portion of sales accounted for by innovative products is smaller, and the chances of producing goods that are new on the market, not just new for the firm itself, are lower. The prevalent model in Italy still seems to be incremental innovation, which requires less financial and organizational resources than formal R&D activity. Total formal R&D spending came to just 1.2 per cent of GDP in Italy in 2013, compared with 2.1 per cent in the EU as a whole and 2.9 per cent in Germany. These figures are very familiar and have been widely discussed; equally well known is the fact that the gap depends not so much on public spending as on business spending, which is undercut by Italian firms’ systematically smaller size than their competitors in the other advanced countries. This feature of the Italian economy means that R&D investment is highly concentrated. In 2013 the three biggest spenders accounted for 56 per cent of total private R&D expenditure, compared with 39 per cent in Germany. And although the per capita number of Italian patents deposited with the European patent office has been rising steadily since the mid1990s, it is still relatively low. Here again, firm size is crucial. The return on formal R&D activity is about the same in Italy as in the other advanced economies. 13 Nor does sectoral specialization, despite the economy’s bias towards traditional, relatively low-tech manufactures, appear to count much; even if we could “impose” Germany’s sectoral composition on the Italian economy, the innovation gap would be narrowed only marginally. 14 Smallness is coupled with an ownership structure and management practices that are often loath to take on the risks of innovation. Meanwhile, the market in venture capital – which specializes in financing the rapid growth of innovative start-ups – is still poorly developed in Italy. Above all, what is decisive is the quality of the work force. Knowledge and the “knowledge factory” Self-evidently, better educated working people have a greater capability for innovation and adapt better to organizational changes. The correlation between the share of universitytrained staff in a firm and its capacity for innovation is high. When the share is above a certain threshold, the probability of the firm’s investing in R&D is greater. If there is little doubt about the benefits of a more highly skilled work force, it is not so straightforward to determine precisely which skills are required. The computerization of production processes achieved to date has put a premium on managerial and intellectual functions and made it possible to turn many repetitive functions, including intermediate functions, over to computers. The Internet and cloud computing make it unnecessary for people working together on a project to be in the same place. Many knowledge-related activities can now be performed via distance interaction. By unbundling productive functions some of them, such as planning and design, can be relocated to the other side of the world. 15 In many countries these trends have led to the rapid growth of the more highly skilled professions at the expense of the intermediate. Many of the workers engaged in the latter have been forced to accept lower-skilled, lower-paid jobs, causing earnings to become polarized. B.H. Hall, F. Lotti and J. Mairesse (2009), “Innovation and productivity in SMEs: empirical evidence for Italy”, Small Business Economics, Vol. 33, No. 1, pp. 13–33. M. Bugamelli, L. Cannari, F. Lotti and S. Magri (2012), op. cit. H.R. Varian (2010), “Computer Mediated Transactions,” American Economic Review, Vol. 100, No. 2, Papers and Proceedings, pp. 1–10; R. Baldwin (2006), “Globalisation: the Great Unbundling(s)”, Globalisation challenges for Europe, Secretariat of the Economic Council, Finnish Prime Minister’s Office, Helsinki. BIS central bankers’ speeches The pervasive impact on all work-related activities of mobile connection to the Internet, which is at once an enormous pool of knowledge and a concentrate of the entire world’s calculating capacity, requires new skills, such as the ability to gather, select and rapidly analyse data drawn from the web. Since this pool is also seriously polluted, the ability to instantly distinguish correct information from erroneous information presented as if it were correct is essential. Calculation capacity must be used sparingly and appropriately. This requires a powerful endowment of skills that need constantly updating to keep pace with often unpredictable changes. To develop a country’s human capital it is no longer enough to furnish a large number of students with a baggage of notions to be applied in routine fashion over the course of their working life. What educators call “competence” is indispensable, namely the ability to mobilize personal resources – knowledge, know-how, aptitudes – and outside informational resources to respond effectively to new situations. 16 The importance of competence is not new. The economic historian Joel Mokyr holds that a key factor in the British industrial revolution of the eighteenth century was precisely the abundance of high-quality professional and craft skills: Effective use of knowledge, however, required not only access and incentives to create and access new technology, but also the competence to make use of it and to carry out the “instructions” contained in the blueprint of the technique. Much of the knowledge employed by artisans and engineers was “tacit”, that is, not formally written down in the “recipe” used for production, but little tricks and know-how based on experience or imitation. 17 On this terrain Italy is not necessarily at a disadvantage. If you talk about the problems and prospects of our economy with entrepreneurs and managers, they regularly bring up one distinctive characteristic of Italy’s successful companies, large and small alike: the ability to adapt their products to the diverse needs of customers, moving away from standard models. That is, Italian “flexibility” is often seen as the proper response to German “reliability”. The bedrock of artisanal skills and professional competence upon which the fortune of a good part of Italian industry was built naturally favours a mind-set emphasizing competences over one tending to the mechanical application of preconceived ideas. Here Italy does not seem to suffer from any handicap. So why haven’t we managed to make greater use of this innate predisposition of Italian entrepreneurs and workers? The fact is that an abundance of skills is not enough. As Mokyr observes with respect to Britain, the right combination of artisanal skills and scientific knowledge is more highly structured: A purely artisanal-knowledge society will eventually revert to a technological equilibrium, in contrast to a society where the world of artisans is constantly shocked by infusions of new knowledge from outsiders. 18 High-level scientific knowledge is essential to be at the frontier of basic and applied research; but a constructive interchange between artisans and scientists must also be developed. That is the story of the telescope. It has been told by Ludovico Geymonat as follows: We know that lens-shaped glasses had long been familiar to optical craftsmen and used by them to correct sight defects, but until Galileo all the representatives I. Visco (2014), Investire in conoscenza, Il Mulino, Bologna. J. Mokyr (2009), The Enlightened Economy. An Economic History of Britain, 1700–1850, New Haven, Yale University Press, p. 107. Ibid., p. 116. BIS central bankers’ speeches of high science had always looked down on them with contempt. Galileo had the courage and the intelligence to make use of these lenses for his astronomical research, artfully combining them to achieve a power of magnification that was truly exceptional for the time. 19 The place where scientific knowledge and the set of competences of the most highly skilled workers are “produced” is the university 20 Italy differs from the most advanced countries by the much smaller amount of resources allocated to universities by families and by the public sector: 21 annual spending per student is less than 20 per cent of per capita GDP, compared with a European average of nearly 30 per cent. 22 Despite the institution of the three-year university degree course, we still lack a clear distinction between “light” higher education – suitable for the blue and white collar tasks that are at the base of the production apparatus – and education designed to supply the economy with a steady flow of specialists and professionals who, in today’s globalized world, can keep up with their peers from INSEAD, MIT or London Business School. A vicious circle of supply and demand has set in. The Italian universities do not supply adequate human capital for a modern, advanced economy, while the firms that should demand it are often not equipped to recognize different degrees of quality and put the right price on them, often because they are too small. Salary levels, even in individual contracts, almost never distinguish between graduates from a low-ranking Italian university and a Harvard Ph.D. Judging by the standards of American, British and German graduate schools or the French grandes écoles, it is almost as if Italy had given up the idea of training its professional elite at home and delegated the task to universities abroad. The average American university student invests nearly $15,000 a year (at 2011 prices) in post-secondary education. The public sector adds another $8,000, bringing the total to $23,000. In Italy, converting euros into dollars at purchasing power parity, the average student gets an investment of $6,500, $2,200 from his or her family and $4,300 from the government. These numbers reflect a radical difference in fundamental social choices. In the US, investment in good education is central to the long-term spending decisions of families and also of the public sector. Anyone with even a slight familiarity with American lifestyles knows the sacrifices and the saving that so many families dedicate to this investment, going so far as to plan their children’s college admission from birth. So it should come as no surprise that that society generates such a large part of the world’s innovations in every field of knowledge and workaday practice. The other substantial difference between these two systems lies in the use that is made of public resources. In the United States the share allocated directly to families in the form of scholarships and student loans is much larger than in Italy; indeed, student loans, which provide especially strong incentives, are practically unknown here. This form of public spending leaves it to the student to determine the end beneficiary of the funds through the choice of university; it has the advantage of spurring the competition for students among universities. In countries where diplomas do not have a mandated legal value, the same regardless of individual or institution, as they do in Italy, universities will not compete by offering easy courses and high grades but by gaining the reputation for enabling their graduates to succeed in the job market, where a degree from a better institution is more valuable. L. Geymonat (1973), Storia del pensiero filosofico e scientifico. Volume II: Il cinquecento Il seicento, 2nd edition, Milan, Garzanti, p. 192. I. Visco, op. cit. S. Rossi (2006), La regina e il cavallo: quattro mosse contro il declino, Rome-Bari, Laterza. OECD (2014), Education at a Glance 2014: OECD Indicators, Paris, OECD Publishing. BIS central bankers’ speeches Still tougher challenges lie ahead. As Brynjolfsson and McAfee observe, “Computers [have] started diagnosing diseases, listening and speaking to us, and writing high-quality prose, while robots [have] started scurrying around warehouses and driving cars with minimal or no guidance”. 23 Technical progress has always left entire occupations behind, soon to be replaced by others. This time around, the process may be extremely intensive, and governing it may prove complicated. In the United States, as in the main European countries, including Italy, one out of every two of today’s jobs risks being automated out of existence within a decade or two. 24 For workers with special skills or simply with the right education there has never been a better time than the present because they are in a position to use technology to generate value. By the same token, for workers with merely ordinary skills there has never been a worse time than now, because the replicants to replace them are advancing rapidly and there will be no “blade runners” to stop them. But what is the right education, what do you need to keep from being swept away by the digital revolution? Acemoglu and Autor contend that work can be classified by a simple twoby-two table: cognitive/manual, routine/non-routine. 25 Labour demand for all routine jobs, including cognitive ones, appears to be on a secular downswing. And in our service-based, white-collar societies, cognitive but routine jobs are extremely numerous; they embrace a large part of the middle class, which is accordingly the most seriously threatened. Conclusions Economists have always sought to determine which variables are decisive for long-term growth. Tangible capital accumulation was long considered the principal lever of development. The focus shifted next to technical progress 26 and then, finally, to its determinants: namely, the capacity of firms, economies and societies to continue to “learn”; 27 dynamism and home-grown creativity, the thrill of an intellectual and entrepreneurial challenge. 28 How can a country acquire these talents? If aided by history, it will find them embedded in its culture and traditions. Otherwise, purposeful political action is required to stimulate the creativity of inventors and entrepreneurs. To foster new entrepreneurs, to convince the existing ones to expand their businesses by separating them from their family fortunes, to reward daring and inventiveness, to discourage positional rents – this must be today’s economic policy priority in Italy. It is a complicated task, touching on all aspects of community life, first and foremost the education system, but also the legal order, competitive conditions, and the efficiency of government. In short, the entire regulatory and institutional environment within which businesses live. E. Brynjolfsson and A. McAfee (2014), op. cit. Ibid. Acemoglu and Autor (2011), Handbook of Labor Economics, Vol. 4, Orley Ashenfelter and David E. Card (eds), Amsterdam, Elsevier. Schumpeter (1934) Theory of Economic Development, Transaction Publishers; Solow (1956), “A Contribution to the Theory of Economic Growth”, Quarterly Journal of Economics, 70 (1); Solow (1957), “Technical Change and the Aggregate Production Function”, Review of Economics and Statistics, 39(3); Romer (1990), “Endogenous Technological Change”, Journal of Political Economy, 98(5); Grossman and Helpman (1991), Innovation and Growth in the Global Economy, MIT Press; Aghion and Howitt (1992), “A Model of Growth Through Creative Destruction”, Econometrica, 60(2). Stiglitz and Greenwald (2014), Creating a Learning Society: A New Approach to Growth, Development, and Social Progress, Columbia University Press. Phelps (2013), Mass Flourishing, Princeton University Press. BIS central bankers’ speeches Indeed, it is within firms that the knowledge and skills acquired in laboratories and lecture halls are harnessed and transformed into a constant flow of innovation, and that the economy is revitalized through the creation of jobs and the generation of demand, income, and wellbeing. It is up to politicians to perform the complex and onerous task of unblocking the virtuous circle of knowledge-innovation-economic recovery by removing futile obstacles, providing the right incentives and disincentives to safeguard matters of real public interest, and finally by ensuring social equity – whilst never forgetting that without growth all equity is vain. BIS central bankers’ speeches | bank of italy | 2,015 | 3 |
Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the Special Governors' session on "Advancing financial literacy through policy and research", 3rd OECD/GFLEC Global Policy Research Symposium to Advance Financial Literacy, Paris, 7 May 2015. | Ignazio Visco: Harnessing financial education to spur entrepreneurship and innovation Speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the Special Governors’ session on “Advancing financial literacy through policy and research”, 3rd OECD/GFLEC Global Policy Research Symposium to Advance Financial Literacy, Paris, 7 May 2015. * 1. * * Introduction Investing in education and knowledge is increasingly recognized as a key factor in ensuring sustainable and inclusive growth. In this process, the role of financial education is both important and wide-ranging. Indeed, with specific reference to the subject of today’s Symposium, the objective of advancing financial literacy should be set in the context of the fundamental goal of improving an economy’s growth potential by encouraging investment, increasing employment, enhancing trade and promoting competition. Improving the investment environment for smalland medium-sized enterprises (SMEs) and their financing conditions is part of this strategy, given the fundamental role that they play in all economies as key generators of employment, income and, ultimately, growth. Hence, it is essential to understand whether and how financial education might be a component in this strategy and what our role, as regulators, should be. 2. Channels through which financial education is important for the innovation and growth of SMEs Innovation is central to economic growth. The role of the State in promoting this is essential, but in the end innovation must be realised by companies themselves. There are at least two areas where financial education, in a broad sense, may have an impact on SMEs’ innovation and growth: their financial structure, on one side, and their managerial skills and corporate governance, on the other. 2.1 The financial structure Financial literacy may help to improve the financial structures of SMEs through a better understanding of the great importance of the communication of information to financial intermediaries and markets. SMEs are characterised by obvious problems of asymmetric information. This creates the conditions for the primary role of banks in their financial structure, since banks are especially experienced in screening and monitoring borrowers’ creditworthiness in order to address these information problems. The incidence of bank debt on financial debt is a bit more than 40 per cent in the euro area and one third in the US. In Italy, where SMEs are more widespread, over 65 per cent of financial debt comes from banks. That this essentially reflects the conditions of our SMEs is easily concluded once we observe that for large firms (those with more than 250 employees), the ratio of bank debt to total financial debt falls below 40 per cent. However, bank debt is not the optimal source for financing innovation; equity is better suited to this end. This is well known and supported by extensive research (see, inter alia, Brown Fazzari and Petersen, 2009, Rajan, 2012, and Magri, 2014). Equity does not require the collateral needed for debt financing, which innovative firms may lack due to the larger incidence of intangible assets. Moreover, it does not increase the probability of bankruptcy, which is usually already high among innovative firms. A greater reliance on equity would also shield firms from the negative spillovers that may arise from the conditions of banks. The last BIS central bankers’ speeches financial crisis has clearly illustrated that firms which depend extensively or exclusively on bank loans may face sudden financial constraints when banks experience difficult times and become more selective in granting loans. This evidence calls for a strong need to increase the role of capital markets – both corporate bond and equity markets – in supporting firms’ innovation and growth. In accessing capital markets, the way firms communicate information to external financiers is crucial. SMEs’ opaqueness and the insufficient transparency of their balance sheets are not exogenous features: they can be reduced. Whether and how an increase in SMEs’ financial education can help firms to understand the importance of financial statements and of sharing information with external financiers is a topic that is currently receiving increasing attention. In fact, there is evidence that after having completed financial education programmes, SMEs subsequently produce more frequent and more transparent financial statements, with a positive impact on some firms’ performance indicators (see Wise, 2013, for a recent analysis on Canadian firms). Within the Capital Markets Union project, aimed at creating a more developed financial market in Europe, the European Commission is now sponsoring initiatives to improve the standards of information transparency and increase their diffusion, specifically for SMEs. Micro-firms and small firms, which, given their size, find it very difficult to access capital markets, will also benefit from a greater transparency of their balance sheets as banks, in granting loans, can use credit scoring models that facilitate the selection of the borrowers. 2.2 Managerial practices and corporate governance Business and financial literacy may also improve managerial practices that are correlated not only with the firms’ size but also with their corporate governance. SMEs are typically family-owned, both in developing and advanced countries. It is less frequent to find that the CEO and other managerial roles are also covered by family members. This situation, however, is very common in Italy: among (manufacturing) familyowned firms, two thirds have a management team comprised exclusively of family members, compared with one third in Spain, one fourth in France and Germany and one tenth in the UK. Recent research shows that managerial practices, more specifically the definition of targets, incentives and supervision, tend to be worse in family-owned firms that are also run by family members (see, inter alia, Bloom and Van Reenen, 2010, and Caselli and Gennaioli, 2013). This is also associated with worse performance. In Italy there is evidence that familyowned firms with only family-member managers are less likely to invest in R&D, a key driver of innovation. Practices such as centralised management or managers’ compensation not linked to performance, also have a distinct and important negative effect on innovation (Bugamelli, Cannari, Lotti and Magri, 2012). However, education programmes may have important effects on managerial ability. Some studies, concerning developing countries, where managerial capital is lower, show that managerial skills can be taught and learnt, although results depend crucially on the approach to training. Other recent surveys also suggest that vocational and general business training appears to be a relatively cost-effective way of promoting business performance and growth (see Bruhn, Karlan and Schoar, 2010, Cho and Honorati, 2013, and Fernandes, Lynch and Notemayer, 2014). In Italy, the ELITE project, run by the Italian Stock Exchange, is an example of a platform offering services to unlisted firms aimed at expanding their size: in addition to financial advice and network connections, firms are provided with effective suggestions for the cultural, organisational and managerial changes required to realise their medium-term projects of growth. 3. Evidence of the level of financial literacy for SMEs As has already been discussed in the morning session of this Symposium, there is evidence that the level of financial literacy of SMEs in emerging countries is very low. But there is BIS central bankers’ speeches growing evidence that the situation in advanced countries is also far from satisfactory. In the case of Italy, weakness in financial literacy in a broad sense seems to affect all the areas previously discussed and might be a factor – together with much-discussed negative institutional aspects, high levels of taxation and insufficient human capital formation – in accounting for the very low average size of firms, and especially their very modest ability to grow. 3.1 Direct evidence of financial literacy and adult skills On average, entrepreneurs and managers of Italian SMEs have a relatively low level of financial literacy. In the 2008 wave of the Bank of Italy’s Survey on Household Income and Wealth (SHIW), heads of households were asked questions aimed at measuring their competencies and financial knowledge. The answers to questions on (i) changes in purchasing power, (ii) differences in the levels of risk of investing in shares and bonds, and (iii) portfolio diversification (questions chosen with the aim of following the lead by Lusardi and Mitchell in their comparisons of financial literacy among individuals and across countries; see Lusardi and Mitchell, 2008 and 2011) show that only 47 per cent of entrepreneurs and managers of firms with less than 100 employees were able to respond correctly to all three (relatively simple) questions. Hence more than half of these entrepreneurs and managers were not able to answer at least one of the relevant questions. This compares to 43 per cent among managers in the public sector or larger (with more than 500 employees) enterprises (the difference between the two groups is only partly explained by their educational qualifications). Less than one quarter of all respondents were able to provide a correct answer to all three questions. These findings clearly suggest that there is significant room for improvement. Perhaps even more worrying is the result from the 2013 OECD Survey of Adult Skills that shows that a significant proportion of Italian adults (higher than in the other surveyed countries) score the lowest levels of proficiency on the literacy and numeracy scales. Less than 30 per cent of adults score level 3 or above (on a 1–5 scale) in both literacy and numeracy skills, compared to more than 50 per cent in the OECD average. Italian workers also display lower skills in literacy and numeracy in the work place (possibly also due to the average size of small companies), even if they seem to score better in their ability to use ICT. An insufficient level of literacy and numeracy skills might impact productivity and innovation even more than financial literacy. 3.2 Indirect evidence of the lack of financial literacy Indirect evidence of the lack of financial literacy can be obtained by looking at the possible inefficient uses of financial instruments by smaller companies. One example is the potential misuse of derivatives by non-financial corporations. Our research shows that in Italy the use of derivatives has been large also among SMEs. Indeed, these instruments have mainly been used to cover interest rate risks by firms that have less balanced financial structures (higher leverage and less liquidity) and are less profitable; the analysis also highlights the relationship between high derivative exposure and financial distress, measured by the firm’s rating (Graziano, 2012). There are claims that those involved in such contracts may lack a thorough understanding of the risks involved. Recent judiciary investigations even go as far as to suggesting, in some instances, that they were purposely inadequately informed. Furthermore, among firms using derivatives, less than half acknowledge this in a recent Bank of Italy survey (Survey of Industrial and Service Firms, 2010), a possible indicator of lack of awareness. Although the number of firms using derivatives has been decreasing in recent years, the average amount per contract has risen, most likely due to an increasing use among large firms as of late. A lack of financial education may also reduce the capacity of firms to reap the benefits from positive changes in the external environment. In Italy, the tax advantage for debt has been BIS central bankers’ speeches widely reduced since 2011 (by the introduction of the so called “Allowance for corporate equity”, ACE), and almost eliminated with subsequent interventions. Unfortunately, a recent survey shows that, even among the largest non-financial corporations, the changes in the equity tax regulation are not sufficiently known (Ambrosetti, 2015). In this context, SMEs are even more likely to be unaware of the new advantageous equity tax treatment. 4. Policy implications More research is obviously needed in this area. Firstly, the economic relevance of (the various components of) financial literacy for SMEs should be better assessed. There are numerous analyses of the impact of financial education and financial literacy on adults’ choices and welfare (see in the case of Italy, Guiso and Viviano, 2015), but almost nothing has been undertaken on firms. Secondly, the impact of different types of financial programmes (characterized, for example, by different durations, channels used and specific content covered) should be thoroughly examined in order to evaluate the relevance of each different instrument. Some (limited) evidence seems to suggest that relatively “simple” programmes are the most effective since they address cognitive biases and difficulties. The same seems to hold for visual programmes or entertainment media-based programmes (see Drexler, Fischer and Schoar, 2014; Lusardi et al, 2014, Berg and Zia, 2013). The evidence seems to point increasingly towards the effectiveness of “just in time” interventions, aimed at specific needs, relevant for individual businesses. A further issue concerns who is best equipped to provide financial education relevant for SMEs’ managers and entrepreneurs. Ideally education should start in schools (mainly at secondary and university levels) but industry associations could play an active role. Banks too may have a special role to play in providing adequate and practical information to their clients. Evidence from Italy suggests that specific information policies implemented by banks have been able to raise the financial literacy of their customers (mainly individuals) and improve their financial asset allocation (Fort, Manaresi and Trucchi, 2014). Finally, a few words on our role as regulators and central banks. Financial education programmes are now offered by a number of regulators, available to both students and adults. At the Bank of Italy we have been developing a programme of financial education for school teachers (coordinated with the Ministry of Education) since 2008. During the academic year 2014–15 it involved approximately 2.800 classes and 63.000 students. They seem to be effective in improving students’ familiarity with money and alternative payment systems (Romagnoli and Trifilidis, 2013). The methodologies used are now being adapted to help the transition from the acquisition of knowledge to the development of skills, and new tools (including visual ones) are being introduced. Other sources of financial education, in the form of simple explanations on the nature and possible uses of various financial instruments, are also available on our website (www.bancaditalia.it/pubblicazioni/guide-bi/). These programmes should not be limited to young students. We are now working with other Italian financial regulators to develop a National strategy for financial education, the first step being the mapping of the existing initiatives available both to schools and other stakeholders. But as regulators we are obviously aware that financial education is complementary to and not a substitute for strong and effective consumer protection and should not therefore be regarded as a silver bullet by any of the interested parties (customers, industry, regulators). Indeed, even financially-literate consumers make mistakes. The financial sophistication, and the number across different countries, of the people fooled by fraudulent investment operations are a sober reminder that financial education does not provide foolproof protection against fraud. Consumer protection must be pursued through regulations on transparency and the conduct of business, which are essential to the relationship between customers and intermediaries BIS central bankers’ speeches where unavoidable information asymmetries make it impossible for the investor to independently monitor the intermediary. Moreover, given the pace at which financial innovation develops, investors are often faced with products with too short a history for the reliable prediction of returns. Customer protection promotes confidence in the enforceability of contracts, an essential ingredient for financial intermediation (see also Visco, 2010). Last year, an ad-hoc directorate was created within the Banking and financial supervision department of the Bank of Italy, with the objective of dealing specifically with consumer protection and anti-money laundering. The Italian model is based on both collective ex-post protection and individual ex-ante and ex-post protection. Individual (ex-post) protection is ensured through both the management and processing of customer complaints and the recourse to the Banking and Financial Ombudsman (Arbitro Bancario Finanziario), which resolves individual disputes between clients and intermediaries. Disputes are submitted to a decision-making body composed of three territorial panels. The Bank of Italy is responsible for auxiliary activities, for which it makes available means and resources, including via technical secretariats established at the branches of the Bank where the Ombudsman’s panels operate. In 2014 approximately 14.000 individual complaints were received and managed; approximately 11.200 claims were submitted to the ABF (10 per cent by corporate clients, 90 per cent by individuals); 65 per cent of the claims were ruled in favour of customers. The information provided both through complaints and claims to the Ombudsman contributes to the off-site supervision of banks and financial intermediaries, a form of collective (ex-post) customer protection. Together with on-site inspections, it represents the basis for specific enforcement measures, which include sanctions, prohibitions and reimbursement orders. These instruments complement (and might also inform) the individual (ex-ante) protection, which is enhanced by financial education both in schools and for adults. * * * To conclude, in recent years, following the financial crisis, trust in finance has been severely damaged. As a whole, it may only be restored through the implementation of a combination of instruments, developed within a coherent framework. This is a fundamental pre-condition for the efficient operation of the financial system. The latter, in turn, is an essential requisite for more financially-literate firms to exploit its full potential. References Ambrosetti Club (2015), “Finance for growth”, http://www.ambrosetti.eu/en/download/studiesand-presentations/2015/finance-for-growthal. G. Berg and B. Zia (2013), “Harnessing emotional connections to improve financial decisions: evaluating the impact of financial education through mainstream media”, World Bank, Policy Research Working Paper, n. 6407. N. Bloom and J. Van Reenen (2010), “Why do management practices differ among firms and countries”, Journal of Economic Perspectives, 24, 1. J. Brown, S. Fazzari and B. Petersen (2009),“Financing innovation and growth: cash flow, external equity, and the 1990s R&D boom”, The Journal of Finance, 54,1. M. Bruhn, D. Karlan and A. Schoar (2010), “What capital is missing in developing countries”, American Economic Review, Papers & Proceedings, 100. M. Bugamelli, L. Cannari, F. Lotti, and S. Magri (2012), “The innovation gap of Italy’s production system: roots and possible solutions”, Bank of Italy, Occasional Papers, n. 121. F. Caselli and N. Gennaioli (2013), “Dynastic management”, Economic Enquiry, 51, 1. BIS central bankers’ speeches Y. Cho and M. Honorati (2013), “Entrepreneurship programs in developing countries”, World Bank, Policy Research Working Paper, n. 6402. A. Drexler, G. Fischer and A. Schoar (2014), “Keeping it simple: financial literacy and rules of thumb”, American Economic Journal: Applied Economics, 6, 2. D. Fernandes, J.G. Lynch and R.G. Notemayer (2014), “Financial literacy, financial education and downstream financial behaviours”, Management Science, 60, 8. M. Fort, F. Manaresi and S. Trucchi (2014), “Adults’ financial literacy and households’ financial assets: the role of banks information policies”, CESifo Working Paper, n. 5047. M. Graziano (2012), “Italian non-financial firms and derivatives”, Bank of Italy, Occasional Papers, n. 139. L. Guiso and E. Viviano (2015), “How much can financial literacy help?”, Review of Finance, forthcoming. A. Lusardi and O.S. Mitchell (2008), “Planning and financial literacy: how do women fare?”, American Economic Review, 98. A. Lusardi and O. S. Mitchell (2011), “Financial literacy and planning: implications for retirement wellbeing”, in O. S. Mitchell and A. Lusardi (eds.), Financial literacy: implications for retirement security and the financial marketplace, Oxford University Press, Oxford. A. Lusardi, A. S. Samek, A. Kapteyn, L. Glinert, A. Hing and A. Heinberg (2014), “Visual tools and narratives: new ways to improve financial literacy”, NBER Working Paper, n. 20229. S. Magri (2014), “Does issuing equity help R&D activity? Evidence from unlisted Italian hightech manufacturing firms”, Economics of Innovation and New Technology, 23,8. R. Rajan (2012), “Presidential address: the corporation in finance”, The Journal of Finance, 67, 4. A. Romagnoli and M. Trifilidis (2013), “Does financial education at school work? Evidence from Italy”, Bank of Italy, Occasional Papers, n. 155. I. Visco (2010), “Financial education in the aftermath of the financial crisis”, Review of economic conditions in Italy, 2. S. Wise (2013), “The impact of financial literacy on new venture survival”, International Journal of Business and Management, 8, 23. BIS central bankers’ speeches | bank of italy | 2,015 | 5 |
Address by Mr Fabio Panetta, Deputy Governor of the Bank of Italy, at the Conference on "Strategic choices for the Italian banking industry", organized by the Associazione per lo Sviluppo degli Studi di Banca e Borsa in collaboration with the Università Cattolica del Sacro Cuore of Milan, Perugia, 21 March 2015. | Fabio Panetta: The transition towards a more stable financial system Address by Mr Fabio Panetta, Deputy Governor of the Bank of Italy, at the Conference on “Strategic choices for the Italian banking industry”, organized by the Associazione per lo Sviluppo degli Studi di Banca e Borsa in collaboration with the Università Cattolica del Sacro Cuore of Milan, Perugia, 21 March 2015. * 1. * * Introduction The powerful stimulus of monetary policy, the depreciation of the currency, and the fall in oil prices are fueling economic recovery in the euro area. There are still risks in connection with the crisis in Greece, geopolitical tensions and the cyclical slowdown in the emerging economies. One of the factors that are impeding investment is the uncertainties surrounding economic agents’expectations. The signs are favourable in Italy too, but the strength of the recovery will depend to a great extent on the proper working of the credit market and the availability of a sufficient volume of finance for the real economy. The latest data show an improvement in credit availability. Banks report that they have eased their lending conditions, the share of firms complaining of lack of finance has diminished, and the decline in lending to firms has moderated. A decisive contribution to the improvement has come from the monetary policy action of the Eurosystem, in particular the programme of quantitative easing. The normalization of the credit market is not complete, however. The terms of access to loans are still uneven. The flow of business credit has increased above all for the least risky borrowers, i.e. the largest and most strongly capitalized corporations. Smaller firms, especially those whose economic and financial balance is more fragile, continue to have problems obtaining outside finance. The performance of the credit market is conditioned by national and international regulatory changes, which are transforming the market’s size, structure and operating model. Moreover, banks are burdened with a very substantial volume of non-performing loans accumulated in the course of the protracted recession. The effects in both the short and the longer term warrant thorough analysis. 2. The financial system and the impact of regulatory reform The recent regulatory reforms in the financial sector are designed to reduce the probability of systemic and solo banking crises and to limit their possible repercussions on the economy. The principal force for change comes from the new capital adequacy provisions. The Basel III rules raise capital requirements, set a minimum leverage ratio (of capital to assets not weighted for risk), and establish minimum liquidity requirements. An additional increase in capitalization has been introduced for “systemically important” banks and, for macroprudential purposes, for the entire system. 1 The regulatory revision is still under way; rules on total loss absorbing capacity are being finalized, to require global systemically For global systemically important banks (G-SIBs) there is an additional requirement for core tier 1 capital, variable between 1 and 3.5 per cent of risk-weighted assets depending on the bank’s systemic importance. Specific requirements can also be introduced for national systemically important banks. Among the measures applicable to the entire system, the provisions for a countercyclical capital buffer can be activated at times of excessively rapid growth of the credit aggregates. BIS central bankers’ speeches important banks to maintain an adequate amount of devaluable or convertible instruments in case of failure. Another major innovation is the Bank Recovery and Resolution Directive (BRRD). The Directive, which is being transposed into Italian law, shifts the burden of bank crises from the public sector to the banks’ creditors (shareholders and holders of other liabilities). This marks the switch from a regime in which big banks were salvaged with public money (bail outs) from one that involves investors in banks’ losses (bail ins). Some countries have instituted explicit rules to separate credit business from the banks’ proprietary financial and trading activity. The purpose is to eliminate indirect subsidies for these riskier activities, setting them apart from such socially valuable activities as provision of credit and payment services. 2 The effects on credit – First of all, these reforms produce a force for the contraction of banks’ balance sheets. The tougher capital and liquidity requirements, the higher funding costs that will stem from the BRRD (which increases the risk of liabilities other than deposits covered by protection schemes), and any direct limits to operations will decrease the supply of credit. Market forces are pushing in the same direction: the increase in credit and sovereign risks has made medium- and long-term wholesale funding more onerous for banks, constituting one more factor reducing the profitability of credit intermediation. The banking system forged by these reforms, then, will be characterized by a greater “safety margin” in terms of both capital and liquidity, but at the same time by lower profitability and a smaller role in financing the economy. What are the likely consequences of this transformation, for the Italian economy in particular? A substantial empirical literature indicates that in equilibrium (that is, once the transition to the new regime is completed), stronger capitalization of banks will have a positive impact on the supply of credit. 3 During the transition, however, the capital increases required by the stronger capital adequacy rules tend to adversely affect lending growth. And the same applies to increased liquidity requirements. Evaluations conducted before the new rules were introduced support this thesis, even while indicating that the adjustment costs will be moderate, not so great as to compromise the net long-run benefits. 4 On the whole, internationally the adjustment to the new standards is being achieved essentially through increases in capital and liquidity, with no substantial impact on the provision of finance to the economy. 5 However, the effects of banks’ deleveraging differ from country to country depending on both structural characteristics – such as the degree of development of the capital markets – and on cyclical factors, such as the stance of monetary and fiscal policies, the cyclical state of the economy and the financial conditions of firms. “Separation” rules have been enacted in the United States, where the Dodd-Frank Act introduced the “Volcker rule”; in Britain, where the Banking Act made the proposals of the Vickers Commission into law; in France, with the Loi de Séparation des Activités Bancaires; and in Germany with the Gesetz zur Abschirmung von Risiken. Within the European Union discussion on the need for similar measures was initiated by the Liikanen Report, which was followed by a Commission proposal for a regulation, presented in January 2014 (the Barnier proposal). The forms of separation differ from country to country. The Volcker rule and the Barnier proposal prohibit banking groups from engaging in certain types of business (such as proprietary trading), while the French, German and British laws only require that they be done by separate units within the group. For the United States, see J. Peek and E.S. Rosengren (1995), “The Capital Crunch: neither a Borrower nor a Lender Be”, Journal of Money, Credit and Banking, Vol. 27, No. 3; for Italy, U. Albertazzi and D.J. Marchetti (2010), “Credit supply, flight to quality and evergreening: an analysis of bank-firm relationships after Lehman”, Bank of Italy Working Papers, No. 756, April. Bank for International Settlements, Assessing the macroeconomic impact of the transition to stronger capital and liquidity requirements (Final Report), December 2010; An assessment of the long-term economic impact of stronger capital and liquidity requirements, August 2010. S. G. Cecchetti (2014), “The jury is in”, CEPR Policy Insight, No. 76, December. BIS central bankers’ speeches The leverage of the main US banks has been reduced by 50 per cent since 2007. 6 The possible repercussions of a credit restriction were moderated by firms’ recourse to the capital market and the shadow banking system, as well as by large-scale corporate self-financing. The transition was facilitated by the increase in the public debt and the exceptional monetary expansion, which increased the amount of resources available to the private sector. The banks’ deleveraging was significant in Europe as well. At a sample of 43 large banks in eleven countries, the leverage ratio came down from 26.0 in 2011 to 21.2 in 2014. Two thirds of the reduction stemmed from capital increases, the other third from a decrease in assets. However, the context of the balance-sheet adjustment was different from that of the United States. In Europe the capital market is a less important source of finance for businesses; the economy consists largely of smaller firms that depend on bank credit. In addition, the capacity of the public sector to sustain the economy and the banks is limited by ongoing fiscal consolidation in many countries and by the European budget rules. In Italy, the difficulty of adapting banks’ balance sheets to the new regulatory and market environment is more acute than in the rest of the euro area, despite lower initial leverage ratios. Firms’ direct recourse to the capital market accounts for an almost negligible share – around 5 per cent – of total finance to the productive economy. The drawn-out recession has undercut firms’ self-financing, especially for smaller businesses. And the margin for intervention by the public sector is narrow indeed, notwithstanding the recent measures to stimulate a rebalancing of firms’ financial structure. Now that signs of economic recovery are emerging in the euro area and in Italy, it is essential to learn the lessons of the crisis and to avoid pro-cyclical policies. The transition to the new equilibrium marked by more strongly capitalized banks with greater liquidity must be gradual and perspicacious. The risks of sudden adjustment must be carefully assessed. The return to growth and the easing of the interest burden will help to increase firms’ profitability and improve credit quality. Banks need to accommodate rising loan demand while maintaining strict control of risk, and of credit risk in particular. In this phase a further stiffening of capital and liquidity requirements could impede the supply of credit, delaying the economic upturn. Such a course would not only heighten macroeconomic risk but would also actually increase the risks for the financial system, the exact opposite of the desired outcome. Microprudential supervision must engage with macroprudential necessities. The targets must be set in such a way as to endow the financial system with more than ephemeral strength, combining the need for bank stability with the need for a recovery in economic activity. At the same time, we must recognize that European integration, which has been revitalized by the project for Banking Union, necessarily entails major changes and constraints on economic agents. The pressure for higher levels of capitalization, which in the current phase has required a considerable effort on the part of Italian banks, derives largely from market forces, from a comparison with other European banks. The impact on crisis management – The BRRD will bring in a new paradigm for the management of banking crises. The Directive requires the formation of a national Resolution Authority, which, in collaboration with the European Single Resolution Board (ESRB) in Brussels, will deal with resolution of “less significant” banks and implement the steps in the resolution of “significant” banks as decided by the SRB. For a sample of ten large banks, financial leverage, calculated as the ratio of total assets to shareholders’ equity, was lowered from 25.2 in December 2007 to 11.8 in June 2014; see P. Bologna, M. Caccavaio and A. Miglietta (2014), EU Bank Deleveraging, Bank of Italy Occasional Papers, No. 235. For an analysis of deleveraging in the US, see L. Buttiglione, P. R. Lane, L. Reichlin and V. Reinhart (2014), “Deleveraging? What Deleveraging?” Geneva Report on the World Economy, No. 16, September. BIS central bankers’ speeches Even at times of ordinary bank activity, the so-called “going concern” phase, the new rules on resolution require completely new activities. The Resolution Authority will simulate the effects of crises, prepare resolution plans, identify solutions to guarantee the continued performance of critical functions. The Authority can intervene – observing the principle of proportionality – to impose changes to banks’ operational, legal and organizational structure, in order to reduce their complexity or to isolate the critical functions with a view to maintaining their operability. In the case of failure, the Authority will determine how costs are shared and how the corporate units without systemic importance will be liquidated. Last year the Bank of Italy provided technical advice to the Government and the Parliament concerning the transposition of the Directive. This transposition must now be completed with the designation of Italy’s national Resolution Authority. The effects on bank-customer relations – As I observed earlier, the main effect of the BRRD will be to limit public intervention in banking crises by requiring creditors to contribute to resolving the banks’ difficulties through devaluation of their assets or conversion of their financial instruments into shares. This change will require banks to pay drastically increased attention to correct relations with customers. Savers must be made fully aware of the risks they run in the event of the bank’s failure. The investments that banks propose to their customers must be perfectly consistent with the investors’ propensity for risk and their financial sophistication. Banks must make sure that their customer relations officers apply the rules on transparency in substantial and not merely formal terms. Substantial efforts have been made in the past to improve the quality and transparency of communication between banks and customers. The Bank of Italy has laid down forceful rules and checked compliance in special on-site inspections. Progress has unquestionably been made. But there is still a great deal of room for improvement, not only in the process of adaptation to the broad, detailed provisions of the regulations but also in truly partaking in the spirit of the transparency and correctness regulations. Even these actions could prove insufficient, however, in the light of the changes introduced by the BRRD. We shall need to consider requiring that retail customers be directed mainly or exclusively to the least risky products – that is, those that under the BRRD will benefit from “depositor reference” in the “pecking order” 7 – and reserving other forms of funding to professional investors. 3. The role of the banks and supervision during the transition In recent years the Italian banking system has strengthened its capital position. Since 2007 core tier 1 capital has been increased from 7.1 to 11.8 per cent of risk-weighted assets, and financial leverage has been considerably reduced. The ECB’s comprehensive assessment of bank balance sheets confirms the resilience of the system as a whole in the face of the exceptionally severe recession afflicting the Italian economy. Nevertheless, changing over to the new rules will require banks to intensify their efforts. In particular, three issues need to be addressed by consistent policies on the part of banks and authorities alike. These concern banks’ efficiency, the management of nonperforming loans, and the adaptation of banking governance to European competition. Bail-ins exempt certain liabilities, such as deposits up to €100,000, bonds backed by the bank’s assets, and short-term interbank debt. In special cases the Resolution Authority can also exempt other liabilities for the purpose of safeguarding systemic stability. The allocation of the losses must follow the preferential ranking laid down by the Directive, which provides among other things that deposits above €100,000 held by individuals and SMEs are not to be drawn on until after other uncollateralized credits. BIS central bankers’ speeches Efficiency – Raising the level of efficiency is necessary to increase profitability, which is now too low to remunerate the capital invested. For a good part of the banking system, efficiency gains can be attained via mergers. The potential benefits of such operations are substantial, on both the cost and the revenue side. But they are not automatic: realizing them requires decisive organizational measures in the rationalization of distribution systems, in risk management, in the exploitation of technology. Mergers may require banks to adapt their level of capitalization to their new mode of operation. Recent experience has shown that international investors are willing to take part in ambitious, credible plans that can transform today’s regional banks into more competitive, better diversified intermediaries operating on a larger scale and serving the financial needs of their customers. The bigger, more efficient banks that will result from mergers can make the inevitable expansion of the capital market an opportunity to increase their revenues. First of all, the prolonged period of low interest rates that looms for the European economy will spur households’ search for relatively higher returns, increasing the demand for asset management services. Moreover, firms’ recourse to the market offers substantial opportunities to provide high-value-added services that absorb relatively little capital and liquidity. Banks can meet these needs by capitalizing on their relations with customers and their knowledge of the economic fabric. This will necessitate the reinforcement of the safeguards against the conflicts of interest stemming from their joint roles as lender, promoter of market access, and asset manager. Non-performing loans – Within the next few years the banks will have to procure from savers and from the international markets the resources they need to repay the very substantial loans they have had from the ECB. At the same time they will be called on to sustain the real economy: lack of a sufficient volume of credit would throttle the recovery. The attainment of these objectives is impeded by the large volume of non-performing loans accumulated during the long phase of recession. The dead weight of these impaired assets reduces the transparency of balance sheets and hinders banks’ recourse to international markets for funding. It also heightens the risk aversion of banks and reduces their willingness to lend. The development of a market in non-performing loans is blocked by several factors. First, the slowness and uncertainty of credit recovery in Italy swells the risk premium that economic agents demand for investing in these assets, driving their price down below their “fundamental” value. And Italian banks, which as a group are now well capitalized, are loath to sell off these non-performing assets at the fire sale prices imposed by this time of exceptional economic weakness. The situation of our banks, in fact, is quite different from that of banks in other countries that have been obliged to resort to systemic solutions for the disposal of non-performing assets. What is more, the simultaneous sale of large volumes of impaired assets by the entire banking system (or a good part of it) would provoke a collapse in prices and thereby, as a practical matter, prevent the conclusion of the sales. If left to market forces alone, the disposal of non-performing loans threatens to be a very long-drawn-out affair. In this kind of scenario, intervention by the authorities can resolve problems of coordination between banks and speed up the disposal process, preventing a “market failure” from ultimately blocking the recovery of the economy. International experience suggests that reducing the weight of non-performing loans on banks’ balance sheets sustains lending growth and helps to create a virtuous circle of economic growth and improving credit quality. The transfer of bad debts would benefit households and firms by increasing the availability of credit and spurring the economic upswing. It would benefit the banking system by reducing the balance-sheet incidence of impaired asset items, thus lowering operating costs and the BIS central bankers’ speeches cost of funding. And it would benefit the public sector, with expanded tax revenues thanks to the cyclical upturn. The measures for the transfer of bad credits now under study centre on market-based solutions. Their precise features will be determined within the next few weeks, in dialogue with specialized operators and with the banks. The intensity of government involvement may be of varying degree, and it is the subject of talks with the European institutions to assess the measures’ compliance with the Commission’s rules on state aid. The European legal framework has changed in the last two years, and measures such as those taken in the past in other countries are no longer practicable. For one thing, those solutions entailed the massive use of public resources, which in our case would also raise questions of budgetary propriety. Significant benefits would also accrue from measures, these too under study, to shorten the duration of credit recovery proceedings, which is much longer in Italy than on average in Europe and constitutes one of the main causes for the build-up of non-performing assets carried on banks’ balance sheets. Last year’s amendments to the Civil Code have removed some of the structural causes of this problem. Hopefully, additional reforms in the near future can shorten or eliminate some of the terms for foreclosure procedures and streamline asset sale procedures, possibly via electronic instruments. Governance – The Bank of Italy has long seen and signalled the need for substantial progress in banks’ governance. Within the limits of our powers, we have acted to strengthen the cooperative banks and induce them to make changes considered indispensable. We have asked them, like all the other banks, to upgrade the membership and improve the functioning of their boards of directors, so as to improve their capacity for governance. We have introduced rules on executive compensation, based on European regulations. We have also asked the cooperative banks to encourage shareholders’ participation at meetings. Notwithstanding the new rules, the improvements achieved have not been decisive. Nor could they have been, given the legislative framework. Our rules could not alter the legal limits to share ownership, the one-person-one-vote provision, or the constraints on the voluntary transformation of cooperatives into other corporate forms. The recent government provisions on cooperative banks permit more thorough monitoring of directors and administrators; they make the banks more attractive to investors, strengthening their ability to raise capital on the market. The most capable managers will succeed in exploiting these opportunities to improve efficiency, move into new markets, and support the best firms. Now the need is to reduce the fragmentation that prevails in the system of cooperative and mutual banks, allowing for forms of integration that preserve these institutions’ local roots and capitalize on individual banks’ membership of banking groups. The solutions must be guided by the essential aim of enabling these banks too to turn readily to the market in order to raise capital, as well as by the purpose of improving the quality of their management. The cooperative banking systems of other European countries are much less fragmented than the Italian system. The prevailing models centre on banking groups, in which the parent company exercises functions of direction and oversight over the banks in the group and, where necessary, can recapitalize them by recourse to the capital market. This model does not denature the cooperative form of the individual banks but allows them to maintain their characteristic mutuality and their community roots. Integration of the system of cooperative credit is in the interest of the cooperative banks themselves, to ensure that cooperative and mutual banks can continue to operate independently in an environment requiring rapid provision for the needs for recapitalization and efficient management, and in the light of the narrower margins for intervention at troubled intermediaries. BIS central bankers’ speeches 4. Conclusion In recent months the European Central Bank, in keeping with its mandate, has dealt effectively and flexibly with the pressures towards the fragmentation of the European markets and with the emerging threat of deflation, preserving the stability of the euro area. Now this kind of flexibility, without prejudice to the rules we have instituted, is necessary at national and at European level in order to wed the objective of soundness of banks with the needs of economic recovery. Where market failures occur, public intervention cannot be ruled out a priori. In their own interest the banks, despite the transition to the new set of European and global regulations and the likely gradual diminution of their role to the advantage of the capital markets, must enhance their capacity to provide financial support to the real economy. I have mentioned the priorities of the current phase: regaining efficiency, managing credit risk and strengthening governance. Mergers can help in attaining these objectives. The financial system cannot solve such problems of the real economy as poor competitiveness and low productivity, on which I have not dwelt today. But it does have an indirect role to play in facilitating the transformation and growth of firms. Banks can play this role while accompanying the development of the capital market and drawing significant advantages from it. It is up to firms to continue their action for a better balanced financial structure, all to the benefit of their ability to stay in the market. BIS central bankers’ speeches | bank of italy | 2,015 | 5 |
Lecture by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy, at the Central Bank of Russia, Moscow, 2 April 2015. | Salvatore Rossi: Towards a European Banking Union – a euro-area central bank supervisor as a first step Lecture by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy, at the Central Bank of Russia, Moscow, 2 April 2015. * * * Should there be one or more financial supervisors? The financial sector needs much closer supervision and stricter regulation than other economic sectors, because financial institutions are critical to the operation of the economy, and finance is based on public trust. Financial regulation addresses negative externalities by modifying private agents’ incentives, constraining their action, and putting mechanisms in place to prevent the most damaging effects of failures, particularly those of banks. Financial supervision is needed to monitor agents’ behaviour and to enforce the rules. Supervision can be grouped into three broad categories: (i) microprudential supervision: surveillance of the safety and soundness of individual institutions; (ii) macroprudential supervision: monitoring the exposure to systemic risk, identifying potential threats to stability arising from macroeconomic or financial market developments, and from market infrastructures; (iii) customer protection: monitoring business conduct and the disclosure of information to customers and other stakeholders. Designing the “optimal model” of a regulatory and supervisory architecture is a daunting task. The empirical evidence does not prove the dominance of any particular model over the others, although several studies have pointed out that weaknesses in regulation and supervision might be factors leading to a financial crisis (Cihák, Demirgüç-Kunt, Martinez Peria and Mohseni-Cheraghlou, 2013). In principle, in any given jurisdiction these functions can be assigned to different authorities on the basis of two different (orthogonal) criteria: either by sector or by function. Or one could choose a “hybrid” model. In addition to this, the authorities, whatever their scope, can be placed within the national central bank or outside it. The financial regulatory and supervisory architecture varies considerably across countries. Tables 1 and 2 show the models chosen by a selection of countries outside and inside the euro area, otherwise referred to as the Euro Zone (EZ). The models are based on data provided in Oreski and Pavcovic (2014) and classified as follows: In the “sectorial” (“vertical”) model there is a regulator/supervisor for each main sector within the financial system – banks, insurance companies, non-bank financial intermediaries, securities markets, etc. – which is in charge of all functions: micro, macro, and customer protection. In the “twin-peaks” model, there is one authority for prudential supervision and another responsible for market conduct and customer protection. Each of them extends its competence over all sectors of the financial system. The “integrated” model combines the preceding two in a sort of universal authority responsible for both prudential and business conduct regulation/supervision for the entire financial industry. Any other solution is dubbed “hybrid” when it has elements of more than one model in it. BIS central bankers’ speeches Finally, Tables 1 and 2 distinguish, but only for the “integrated” and “hybrid” frameworks, whether the authorities are, totally or mostly, part of the central bank (CB) or not. The evolution over the last 15 years is also shown for all countries. Outside the EZ we find two twin-peaks models (Australia and the UK), one sectorial (USA), and one hybrid (Canada). The four remaining frameworks (Japan, the Russian Federation, Sweden, and Switzerland) are integrated, and only in the case of Russia is the single authority part of the central bank. In the sectorial and twin-peaks cases, the central bank is involved at least partially. In the EZ, we see two twin-peaks models (Belgium and the Netherlands), one sectorial (Spain), two hybrid (France and Italy, in both cases with a heavy involvement of the central bank), and three integrated (Austria, Finland, and Germany). Theoretically, all these models have advantages and disadvantages.1 The merits of one model are always the demerits of another, and vice versa. The main arguments in favour of greater integration are: i) economies of scope, ii) better assessment of risks, iii) effectiveness (better cooperation within one organization than between many agencies), iv) less regulatory arbitrage or supervisory gaps, and v) increased accountability. The main drawbacks of integration cited in the literature are: i) dominance of one goal over the others, ii) misalignment of incentives (for example, focus on a particular objective only because it is more easily monitored by public opinion), iii) excessive bureaucracy, iv) a tendency to assign an ever-increasing range of functions to a unified agency, and v) an excessive concentration of power. The relative weights attributed to the advantages and disadvantages in each country explain the variety of models adopted. They in turn depend on political economy factors, and may change over time. Figure 1 shows how the distribution of the four main institutional models – twin-peaks, sectorial, integrated, and hybrid – has changed since the late 1990s in a wide sample of 80 countries. We see a decline of the sectorial model and a growing diffusion of the others, especially the integrated model. The increasing integration between financial intermediaries and activities, coupled with the consequences of the global financial crisis, has pushed more and more countries towards some consolidation of agencies.2 In Italy, as I said before when commenting on Table 2, a hybrid model applies. The various authorities involved in regulating and supervising the financial system have mostly sectorial dividing lines: the Bank of Italy for the banking sector, Ivass for the insurance sector, and Covip for pension funds, all of them involved in both prudential supervision and consumer protection. But there is also an element of the twin-peaks model, with Consob in charge of market conduct and transparency for all listed intermediaries, and the Antitrust authority in charge of protecting competition in all markets, including the credit and financial ones. Furthermore, Ivass, the insurance regulator, was recently placed under the umbrella of the Bank of Italy, while remaining a separate legal entity. Furthermore, borders between the sectorial authorities are somewhat blurred, and conflicts of competence arise from time to time. See for example Abrams and Taylor (2000). Borio and Filosa (1994) discuss the implications for supervision of the transformation of the financial industry. BIS central bankers’ speeches Monetary policy and supervision under one roof? Effects on the independence of a central bank Part of the academic and political debate about the best financial supervisory architecture has been devoted to whether the central bank should be involved in the prudential supervision of banks.3 Supervision within the central bank? – This specific debate on the benefits and risks of entrusting a central bank with banking supervision is a long standing one.4 The literature generally concludes that no single pattern of division of supervisory responsibilities between the central bank and other authorities is unquestionably superior. Goodhart (1988) argues that central banks have been historically involved in supervisory functions because of their role in stabilizing the financial system, acting as lenders of last resort (LOLR). In the late 1990s in many countries financial supervision was moved outside central banks, into cross-sectorial or specialized authorities. According to Eichengreen and Dincer (2011) this process was related to the strengthening of the independence of central banks, in light of their narrow mandate to achieve price stability. However, the global financial crisis has shown that central banks cannot disregard financial stability considerations, whether they are part of their explicit mandate or not. The most widely cited benefits of having monetary policy and bank supervision residing under one roof are related to: i) the exchange of information, ii) shared concern for financial stability.5 The first benefit may be well illustrated by the UK experience: the failure of supervisors to head off problems in Northern Rock and prevent the first bank run in more than a century is an outcome widely attributed to imperfect coordination and inadequate information-sharing between the FSA and the Bank of England (Eichengreen and Dincer, 2011). Bank-specific information is very important for central banks when they act as lenders of last resort. The central bank is the ultimate guarantor of financial stability during a crisis. In performing its LOLR function, the central bank has to assess the liquidity and solvency of its counterparts. More generally, central bank risk management would benefit from better access to information on the financial health of banks to assess the quality of the collateral that these banks provide. Especially in times of tensions, having such information in house increases the timeliness of the information flow. Bernanke (2007) underlines that supervisory responsibilities give the central bank access to a wealth of granular on each bank’s organization, management structure, lines of business, financial condition, internal controls, risk-management practices, and operational vulnerabilities. This is beneficial for the conduct of monetary policy because banks play a central role in the transmission of monetary policy impulses. For example, supervisory information on bank capital is useful to assess the contribution of capital constraints to credit developments (Bernanke and Lown, 1991). Similarly, monitoring the portfolio choices of banks is useful to assess the consequences of monetary policy on the accumulation of risks. This information improves the ability of central banks to prevent financial instability. Symmetrically, supervision benefits from information that central banks acquire from their frequent contacts with banks for monetary policy purposes. Also the role that central banks traditionally play in payment and settlement systems provides them with additional sources of For an updated and systematic discussion of the relationship between central banks, financial regulation and supervision after the global financial crisis, see Eijffinger and Masciandaro (2011). See, among others, Pisani-Ferry, Sapir, Veron and Wolff (2012). See for example Goodhart (2000) and Mishkin (2001). BIS central bankers’ speeches information on linkages between intermediaries. Rapidly changing financial flows can affect the stability of intermediaries.6 The second benefit is related to the common concern for financial stability. Historically financial stability has been a main task for central banks, even without an explicit mandate. In many countries it has been a fundamental factor for their establishment. Central banks conduct monetary policy to achieve price stability – in most cases their primary goal – and this in turn fosters broader macroeconomic stability and contributes to financial stability. But often central banks have specific responsibilities in the financial stability sphere, as this is a key precondition for price stability. Central banks with prudential supervisory powers can pursue the objectives of price stability and financial stability with a wider set of instruments, whereas a central bank with monetary policy powers only might end up being overburdened. A common roof and the effects on independence – The independence of central banks is a topic deeply debated almost from the time of their inception.7 In an essay of 1824 David Ricardo identified the three pillars of central bank independence: institutional separation of the power to create money from the power to spend it; a ban on the monetary funding of the State budget; and the central bank’s obligation to give an account of its monetary policy. Ricardo’s suggestions were taken up by the Brussels Conference of 1920. Price stability was indicated as the primary objective of monetary policy but – as the Final Report of the conference maintained – if it was to be achieved, it had to be entrusted to central banks that were independent of their governments.8 These principles were forgotten for many years after the Second World War (WW2). The conviction that a certain degree of inflation was necessary to support employment and growth came to the fore in economic thought and in the minds of policy makers. In many countries monetary policy was dominated by budgetary requirements (fiscal dominance) and central banks acted as buyers of last resort of government securities when they came onto the primary market.9 The independence of central banks enjoyed little institutional protection. The stagflation of the 1970s suddenly brought to light what farsighted economists, such as Edmund Phelps, had already foreseen in the previous decade: in the short term there may be a trade-off between inflation and unemployment, but not in the long term.10 This radical rethinking of the theory was accompanied by profound changes in the organization and behaviour of central banks. Economic literature once again looked at price stability as a supreme value and pointed to two prerequisites: the independence of the institutions called to guarantee it, i.e. central banks, and the adoption on their part of explicit objectives. Here it comes a third benefit from having monetary policy and supervision under the common roof of the central bank: it mutually reinforces independence. As recalled by the IMF’s principles, independence is a requirement not only for monetary policy but also for A number of theoretical papers analyse how illiquidity can turn into insolvency for intermediaries (e.g. Diamond and Rajan, 2011, 2012). This section is based in part on Rossi (2013). See Spinelli and Trecroci (2006). For the Bank of Italy, see Gaiotti and Secchi (2013). See Phelps (1967, 1968). BIS central bankers’ speeches effective supervision.11 Italy’s historical experience suggests that attributing the supervision of banks to the central bank can not only strengthen the independence of the supervisor: credibility as a tough supervisor can in turn reinforce its reputation and standing in the enactment of monetary policy. However, we must be aware that the common roof entails the risk of a conflict of interest. The central bank may have an incentive to keep monetary policy too loose to avoid the adverse effects of tighter money conditions on bank earnings and credit quality12 and provide liquidity to weak banks to avoid triggering losses.13 A supervisor that is also a central bank may be tempted to forbearance during a downturn, delaying the closure of problem banks in the hope that macroeconomic conditions improve and the problems in the financial system disappear on their own. The potential for conflicts of interest between monetary policy and prudential supervision is debatable. In many instances, such as during the global financial crisis, financial instability can generate deflationary pressures. There is no clear evidence that central banks with supervisory powers were more or less prone to forbearance than other supervisory agencies. Situations of conflicts of interest between supervisory objectives and monetary policy goals may exist, but these conflicts would not be resolved by simply attributing the functions to separate authorities. Having separate authorities would make coordination even more burdensome. Towards a European Banking Union: the new regulatory and supervisory framework Origin and motives of the European Banking Union project – The construction of Europe since the end of WW2 has followed a long and winding road.14. The Banking Union (BU) is the most recent step. It is still an ongoing process; it has been designed to solve what can be considered the worst crisis ever of the European edifice: the sovereign debt crisis. We know where the crisis came from. The triggers were local financial crises in two small economies of the EZ, Greece and Cyprus. The response by the European governments and institutions was flawed, and fuelled markets’ suspicion that the euro was not in fact irreversible, as the European rhetoric had claimed until then: a sort of disaffection towards the euro was apparently spreading in important founding countries, particularly in the North of Europe. Market turmoil receded after the announcement of the Outright Monetary Transactions programme (OMT) by the ECB (“Whatever it takes”), but meanwhile banks in high-publicdebt countries had become the main target of the markets’ concern: they held a considerable amount of public bonds of their respective sovereigns in their balance sheets; the riskiness now attached to the sovereigns was being transmitted to the domestic banks’ balance sheets and back to the sovereigns, perceived as the ultimate support to their domestic banking systems, in a vicious circle. How to sever the sovereign-bank link? The safest way to do it was straightforward: we needed to convince the markets that the EZ banks belong to a common system, so that if The IMF FSAP principles state that “The supervisor possesses operational independence, transparent processes, sound governance, budgetary processes that do not undermine autonomy and adequate resources, and is accountable for the discharge of its duties and use of its resources.” This point has been made, among others, by Goodhart and Schoenmaker (1995). See for example Brunnermeier and Gersbach (2012). See Rossi (2014). BIS central bankers’ speeches one of them fails, or is likely to fail, bailing it out is no more the responsibility of one country, but of all. However, if we wanted all the EZ countries, in particular the low-public-debt ones, to share such a financial responsibility, we had to allow them also to share the ex ante supervision on all banks, not only on the domestic banks of each country. In other terms, we needed to create a Single Supervisory Mechanism (SSM). The BU project was launched in 2012, and it was conceived as an institutional framework with three pillars: an SSM, a Single Resolution Mechanism (SRM), and a Single Deposit Insurance Scheme (SDIS). The three pillars were originally meant to be concurrent, symmetric and logically connected. The outcome has been different. The SDIS has been postponed to an indefinite future. On the crucial issue of bank resolution, a long and tiresome negotiation took place, which eventually brought about a reverse approach: it was decided that sharing the cost of a banking crisis among all the EZ countries was not for now; it is foreseen as the final step of a many-year-long process, and in any case it will involve private funds only (the Single Resolution Fund, financed by all the EZ banks). In particular, the use of money from the taxpayers of countries other than the one where the bank’s head office is located has been ruled out – contrary to the original intention. During the negotiations Italy offered a view consistent with the very motives behind the BU project: the SSM was supposed to be the prerequisite of a common public backstop for distressed banks, with the aims of removing the “tail risk” from the EZ banking system and cutting the link between sovereigns and banks; any moral hazard could be prevented by an effective common supervision. This view, also shared by several other countries, was eventually rejected by the majority. Meanwhile the SSM was created. The new system has been in place since last November. It is centered on the European Central Bank (ECB) and comprises all the national competent authorities (NCAs) of the euro-area countries. The Single Supervisory Board (SSB), which includes 6 members appointed by the ECB and 19 representatives of the NCAs, is directly responsible for supervision of around 120 “significant” banks. In practice, supervision of each of those banks is conducted by a Joint Supervisory Team (JST) comprising experts from the SSM staff and from the NCAs of the countries where that bank is located. We now have in Europe a very complicated regulatory and supervisory framework for banks. Regulation is provided by the EBA, an EU-wide entity, while supervision is the responsibility of the SSM, but only for EZ banks. Bank resolution is disciplined by a specific EU Directive and governed by the SRM. The European Systemic Risk Board (ESRB) is in charge of macroprudential monitoring.15 This is the European layer. The domestic layer, the NCAs, is also fully involved in both regulation and supervision, to various degrees. The two layers coexist, although with different responsibilities: the multinational nature of the Mechanism implies a multiplication of resources dedicated to the various tasks, also because of the need for coordination. It is a costly exercise. The “common roof” choice – A crucial decision was to place the SSM within the ECB. It came after a prolonged discussion, where different lines of thought were confronting. The risk of a conflict of interest between monetary policy and supervisory action was meant to be mitigated by separating the analysis aimed at supervision from the one aimed at monetary policy, and analysis from decision-making. The SSM Regulation actually establishes the separation between the monetary policy function and supervision.16 Recital 65 of the Regulation states that the ECB is responsible for Although some macroprudential supervision tasks have also been assigned to the SSM. Council Regulation (EU) No 1024/2013 of 15 October 2013 conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions. BIS central bankers’ speeches carrying out monetary policy functions with a view to maintaining price stability in accordance with Article 127(1) TFEU, while the exercise of supervisory tasks has the objective of protecting the safety and soundness of credit institutions and the stability of the financial system. The Regulation thus establishes that monetary policy and supervision should be carried out in full separation, in order to avoid conflicts of interest. The road ahead – Is there a risk that markets will see the BU as a fragile, lopsided creature; that financial market fragmentation will remain untamed; that the BU objectives will be missed? Not necessarily. What we have achieved so far may be not the first best, but it is something. The SSM, the starting point, is valuable per se. The Bank of Italy has supported it from the outset, and will continue to cooperate to make it a success. What the NCAs have to do is to build a real single house. We have to bring to this common endeavour the best practices and the most useful experiences. In order to exploit the potential of the SSM, it is essential to harmonize supervisory practices so that the resulting single standard be the highest possible, in terms of both prudence and effectiveness in financing the real economy. In the years preceding the global financial crisis, harshly competing and gigantic intermediaries, mostly in the US, pushed the authorities to lower their regulatory and supervisory standards; on the other hand, shadow banking activities were developed, totally hidden from regulators and supervisors. This latter phenomenon still poses a risk: overburdening banks with ever increasing requests for more capital may be pro-cyclical and counterproductive from the point of view of systemic stability, in that it incentivizes finance to go further into the shadow. We must let our banks do their job better than they did before the crisis. They must be more stable, more efficient, more competitive, to the benefit of the whole economy. We must dissipate every remaining uncertainty in the markets regarding the irreversibility of the euro, so that the common EZ monetary policy can work fully and correctly. References Abrams, R. K., and Taylor, M. W., 2000. Issues in the Unification of Financial Sector Supervision, IMF Working Paper 213. Bernanke, B. S., 2007. Central Banking and Bank Supervision in the United States, speech at the Allied Social Science Association Annual Meeting, Chicago, Illinois – January 5. Bernanke, B. S., and Lown, C. S., 1991. The Credit Crunch, Brookings Papers on Economic Activity, pp. 205–39. Borio, C., and Filosa, R., 1994. The Changing Borders of Banking: Trends and Implications, BIS Economic Paper, No. 43. Brunnermeier, M., and Gersbach, H., 2012. True independence for the ECB: Triggering power – no more, no less, VoxEU, 20 December. Cihák, M., Demirgüç-Kunt, A., Martinez Peria, M. S., and Mohseni-Cheraghlou, A., 2013. “Bank regulation and supervision in the context of the global crisis”. Journal of Financial Stability, 9(4), 733–746. Diamond, D. W., and Rajan, R. G., 2011. “Fear of Fire Sales, Illiquidity Seeking, and Credit Freezes”. The Quarterly Journal of Economics, 126(2), pp. 557–91. Diamond, D. W., and Rajan, R. G., 2012. “Illiquid Banks, Financial Stability, and Interest Rate Policy”. Journal of Political Economy, 120(3), pp. 552–91. BIS central bankers’ speeches Eichengreen, B., and Dincer, N., 2011. Who should supervise? The structure of bank supervision and the performance of the financial system. NBER WP 17401. Eijffinger, S., and Masciandaro, D., 2011. Handbook of Central Banking, Financial Regulation and Supervision. Edward Elgar, Cheltenham. Feldman, R. J., Kim, J., Miller, P., and Schmidt, J. E., 2003. “Are Banking Supervisory Data Useful for Macroeconomic Forecasts?” The B.E. Journal of Macroeconomics, vol. 3 (Contributions). Gaiotti, E., and Secchi, A., 2013. Monetary policy and fiscal dominance in Italy from the early 1970s to the adoption of the euro: a review, Banca d’Italia Occasional Paper No. 141. Goodhart, C., 1988. The evolution of central banks. MIT Press, Cambridge. Goodhart, C., 2000. The Organizational Structure of Banking Supervision, Occasional Papers, no.1, Basel: Financial Stability Institute, November. Goodhart, C., and Shoenmaker, D., 1995. Should the Functions of Monetary Policy and Banking Supervision Be Separated? Oxford Economic Papers, vol. 47 (October), pp. 539–560. Mishkin, F., 2001. “Prudential Supervision: Why Is It Important and What Are the Issues?” in Frederic Mishkin, ed., Prudential Supervision: What Works and What Doesn’t, Chicago: University of Chicago Press. Oreski, T., and Pavkovic, A., 2014. “Global trends in financial sector supervisory architectures”, in Proceedings of the 5th International Conference on Design and Product Development. Phelps, E. S., 1967. “Phillips Curves, Expectations of Inflation and Optimal Unemployment over Time”, Economica, Vol. 34, pp. 254–281. Phelps, E. S., 1968. “Money-Wage Dynamics and Labor-Market equilibrium”, Journal of Political Economy, Vol. 76, pp. 678–711. Pisani-Ferry, J., Sapir, A., Veron, N., and Wolff, G. B., 2012. What kind of European Banking Union, Bruegel Policy Contributions, n. 12, June 2012. Rossi, S., 2013. Post-crisis challenges to central bank independence, speech given at the LBMA/LPPM Precious Metals Conference. Rossi, S., 2014. Verso l’unione bancaria europea: in fondo a una strada lunga e tortuosa, speech given at the conference “Banking union and the European financial system” Università degli Studi di Modena e Reggio Emilia. Spinelli, F., and Trecroci, C., 2006. “Maastricht: New and Old Rules”, Open Economies Review, Vol. 17, pp. 477–492. BIS central bankers’ speeches BIS central bankers’ speeches BIS central bankers’ speeches | bank of italy | 2,015 | 5 |
Concluding remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Ordinary Meeting of Shareholders 2014 - 121st Financial Year, Bank of Italy, Rome, 26 May 2015. | Ignazio Visco: Overview of economic and financial developments in Italy Concluding remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Ordinary Meeting of Shareholders 2014 – 121st Financial Year, Bank of Italy, Rome, 26 May 2015. * * * Ladies and Gentlemen, Last year was one of important changes: in Europe, by reason of the evolving institutional context and major economic and monetary policy decisions; in Italy, by reason of the quickening pace of the reform effort. It was a year of difficult choices, whose early results – significant but still fragile – must be resolutely defended. The economic recovery that got under way in Italy in the first quarter of this year is likely to strengthen in the current and subsequent quarters. For the Bank of Italy, 2014 was a year of engagement in the euro area in formulating and implementing monetary policy and launching the Single Supervisory Mechanism, and in Italy in enhancing our services to the national community and further modernizing our organization and operations. The Bank of Italy’s total assets declined by nearly €24 billion, to €530.6 billion, reflecting a reduction in Eurosystem refinancing operations. This year the implementation of the extraordinary securities purchase programmes will expand our balance sheet again. Our gross profit fell from €6.9 billion to just under €6 billion in 2014. Today the Board of Directors proposes that this meeting allocate €1.8 billion to general risk provisions and €750 million to statutory reserves. Taking market conditions into account, it also proposes to distribute dividends of €340 million to shareholders. On the basis of the indications laid down in the Statute, €1.9 billion goes to the State, in addition to a tax liability of €1.2 billion. At its meeting on 30 April the Board of Directors determined that in future years dividends should ordinarily be in the range between last year’s and this year’s amounts, conditional on the size of net profit and on capitalization needs, unless the general conditions of the financial markets or the Bank’s profitability have undergone significant changes. The commencement of the redistribution of holdings of the Bank’s shares, as required by law, may be facilitated by awareness of this orientation. Meanwhile the Bank is working on the dematerialization of the shares. Once the new system is fully phased in, transfers will be made electronically in a dedicated market segment, so as to make the investment liquid. The Report on Operations and Activities, which we present today together with our Annual Report, describes in detail the tasks carried out, organizational developments and resource management in 2014. Practically 40 per cent of the work done by the Bank of Italy’s staff relates directly to our participation in the Eurosystem and the Single Supervisory Mechanism. Our technical structures are heavily and constantly engaged in the committees and working groups acting in support of the decisions of the ECB Governing Council. Designing and implementing the monetary policy for the euro area draws on a broad range of competences in the fields of economic analysis and market intervention. To date, nearly a third of the total liquidity supplied by the ECB’s targeted longer-term refinancing operations has been taken up by Italian banks. For the Bank of Italy, the outright purchase programmes of private and public securities have entailed daily market interventions averaging €450 million. The launch of the Single Supervisory Mechanism has required an extraordinary allocation of resources. We have taken part in its construction by making our knowledge and experience available. The new European system of banking supervision has been designed as a “system of authorities”. The ECB and the national authorities agree jointly on decisions and BIS central bankers’ speeches practices. The ECB has direct supervisory responsibility for the 123 most important, or “significant”, banks; decisions are taken by the Governing Council acting on a proposal from the Supervisory Board on which the national authorities sit. Each of these banks is supervised by “joint supervisory teams” consisting mostly of staff drawn from the national authorities – chiefly but not exclusively those of the country in which the bank is headquartered. The Bank of Italy has assigned 58 of its analysts to the teams supervising Italian banks, and another 20 to 18 groups responsible for supervising non-Italian banks. Finally, 60 Bank of Italy inspectors are assigned to on-site inspections at significant banks. The number of experts involved in these activities will grow further already in the coming months. The new arrangement is complex; it seeks to balance an overall vision with immediate and effective action that makes the most of the national authorities’ accumulated knowledge and expertise. The result is a network architecture in which every significant bank is examined by many eyes of diverse nationalities. The Bank of Italy dedicates considerable resources to the oversight of market infrastructures and the provision of European-wide payment services. The migration to the new Single Euro Payments Area for retail payments has been successfully completed. With the Deutsche Bundesbank, the Bank of Italy operates the TARGET2 settlement system for payments within the euro area, and we will also operate the TARGET2-Securities platform for settling securities transactions. For the “less significant” intermediaries, supervisory responsibility and direct supervisory action are left to the national authorities, within the framework of the common mechanism. In Italy, this covers 56 banking groups, 435 non-group banks, and 77 branches of foreign banks, plus 456 non-bank financial intermediaries also subject to our prudential supervision. The Bank of Italy is also tasked with activating macroprudential policies to safeguard the overall stability of the financial system. When enlarged to include two additional members, our Governing Board also takes externally relevant decisions concerning insurance supervision prepared by the Insurance Supervisory Authority. As part of our action to protect the consumers of banking and financial services, inspections focusing on transparency and correctness in customer relations were carried out at 124 intermediaries in 2014. In 71 cases shortcomings were detected and actions taken to overcome them and improve service quality. The public is increasingly sensitive to this issue. We received nearly 14,000 complaints last year, 2,200 more than in 2013, and we take them into account in our supervisory action. Appeals to the Banking and Financial Ombudsman increased by 40 per cent to over 11,000, with more than two thirds of the 8,500 rulings favourable to customers. The Financial Intelligence Unit was reorganized and its analytical capability reinforced. Thanks to investment in skills and technology, together with the dedication of its staff, the Unit handled the steadily rising number of suspicious transaction reports, which has more than tripled over the past five years to 72,000. It further shortened its response time last year, informing the law enforcement and judicial authorities more and more promptly. In recent months we have decided on a new rationalization of our branch network following that completed in 2010. By the end of 2018 the number of branches will be reduced to 39, down from 58 today and 97 in 2007. The new configuration takes account of developments in technology, concentrating activities and personnel in larger units endowed with specialized professional skills that are updated constantly; it will improve service quality, maintaining a balanced territorial presence. The duties of the branches will be extended in the areas of consumer protection, supervision of non-bank intermediaries, assessment of asset eligibility for monetary policy operations, and inspection and control of cash circulation. BIS central bankers’ speeches Today the Bank has 7,100 employees, including nearly 170 seconded to other institutions, primarily the ECB. In 2009 we had a staff of over 7,500. In the past five years the Bank’s operating expenses have diminished by more than 14 per cent in real terms, thanks above all to measures to curb current expenses. With investment in technology, among other things, our drive for organizational improvement will proceed. In managing human resources we will continue to adapt to social and economic changes. In agreement with the trade unions we have enhanced flexibility in working hours. We will reinforce the areas whose workload has been made heavier by the new European arrangements. We will continue to invest in people, seeking out and rewarding excellence, fostering career-long development of skills and promoting diversity. On behalf of the Board of Directors, the Governing Board, and myself personally, let me voice our appreciation and gratitude to the women and men who work at the Bank of Italy, whose integrity and capability have always constituted the strength of this institution. Monetary policy and economic growth in the euro area The past year saw a slowdown in the emerging economies, related to the dwindling stimulus of commercial integration and the emerging effects of structural fragilities. Developments in the advanced countries diverged. Economic activity in the euro area remained weak for much of last year. Within the area, growth differentials narrowed but the remaining cyclical differences were reflected in the labour market: the increase in employment was robust in Germany and Spain, very modest in France and Italy. Although the unemployment rate fell slightly it was still high, especially among young people. Inflation continued to decrease, with the change in consumer prices turning negative at the end of the year. We have emphasized on several occasions the risks stemming from a prolonged period of exceptionally low inflation, if not outright deflation. Studies carried out by the Bank of Italy show that the price deceleration is largely due not only to the drop in energy costs, but also to the lack of aggregate demand. They confirm that there is a risk of disanchoring of inflation expectations, which have reached an historical minimum. They point to the potentially heavy cost of low inflation, especially in conjunction with high levels of public and private debt. In view of these risks the Governing Council of the ECB cut its policy rates to the lower bound, started new targeted longer-term refinancing operations, and launched covered bond and asset-backed securities purchases. In January of this year it decided to extend its asset purchases to public sector securities. Under the expanded asset purchase programme the ECB will make monthly purchases amounting to €60 billion until the end of September 2016, and in any event until it sees a sustained adjustment in the path of inflation consistent with a return to price stability. This action will restore the Eurosystem’s balance sheet to the peak levels recorded in the first half of 2012. About €150 billion worth of Italian government securities will be purchased, of which more than €130 billion by the Bank of Italy and the remainder by the ECB. The single national central banks will bear the risks associated with the government securities they purchase. This decision takes account of the concerns of some members of the Governing Council that the programme could lead to transfers of resources between countries. Full risk sharing would have been more in line with the singleness of monetary policy and consistent with the Treaty on European Union. However, the measure’s effectiveness is undiminished: it depends above all on the scope and timing of the action. The decision in favour of only partial risk sharing reflects the delays and limitations of the process of European unification. The asset purchases boost economic activity and raise inflation through several channels: they reduce yields on public sector securities, with effects on other segments of the financial market and on the conditions for credit to households and firms; they cause a depreciation of the euro, which impacts on imported inflation and on exports; they increase the value of BIS central bankers’ speeches financial assets and hence the private sector’s spending capacity; and they improve inflation expectations and public confidence. Positive effects on the financial and foreign exchange markets emerged as soon as the preparation of the programme was announced. From the beginning of November, and despite a rise in recent weeks that mainly reflected improved growth and inflation expectations, yields on ten-year German and Italian government securities have fallen by about 20 and 60 basis points respectively. The euro has depreciated by more than 10 per cent against the dollar and by 6 per cent in nominal effective terms. The stimulus has spread to market segments not directly affected by the asset purchases and to credit supply conditions. Inflation expectations have begun to improve, though only slightly. Fears of deflation have abated, but the positive effects of the programme observed so far should not weaken our determination to take it forward; on the contrary, they are confirmation that we need to carry it through to the end. Improvement depends on the credibility of this commitment, and the cost of non-completion would be very high. Inflation must be brought permanently back to levels consistent with an annual growth in consumer prices of below but close to 2 per cent in the medium term. With the start of purchases we have entered a new, partially uncharted, territory of extremely low interest rates even on medium- and long-term maturities. In seven euro-area countries these are now negative on horizons up to three years. In the second half of April, just before the recent increase, German rates were negative on maturities up to nine years. Fears have been voiced that the programme could encourage excessive risk taking in the search for higher yields, that it could generate liquidity tensions in some market segments, and harm some categories of financial operator such as insurance companies and pension funds. These risks must be carefully weighed but not overestimated. There are no signs to date that low interest rates are provoking generalized imbalances. In the euro area as a whole, financial asset and property prices do not appear to be under speculative pressures, investors’ risk propensity is still low, and credit growth is weak. Local and sectoral tensions can be controlled with macroprudential measures, as happens already in some other euro-area countries. Asset purchases are being made gradually and continuously so as not to distort price formation; securities lending by the ECB and some national central banks, including the Bank of Italy, is helping to keep the secondary market liquid. The potential repercussions for specific sectors are not being ignored. The EU-wide stress test carried out in 2014 revealed that the exposure of insurance companies to the risks of a prolonged period of low interest rates is significant in some euro-area countries; it is less marked in Italy, thanks to a basically balanced financial structure. Insurance companies can limit these risks by seeking a better match between the yields and duration of balance-sheet assets and liabilities, improving operating results through diversification of portfolio securities, increasing technical reserves and, where necessary, adjusting their obligations to policyholders to the new market scenario. The authorities should step up their supervisory action and prudential controls as recommended by the European Insurance and Occupational Pensions Authority. The risks, both real and financial, would have been far greater had we not begun the asset purchases. The greatest threat to the euro area’s financial stability comes from the prospect of a stagnation of production and low inflation, which the programme combats. Signs of a recovery of economic activity in the euro area have gained strength since the end of 2014. According to the latest projections, output growth will acquire a solid basis this year and gain momentum in the next, largely thanks to the support of monetary policy. There is still the risk of a further weakening of productive activity in the emerging countries and of a sharpening of international tensions. BIS central bankers’ speeches The flare-up of the Greek crisis has had few repercussions to date on sovereign risk premiums in the rest of the area thanks to the reforms undertaken in many countries, the progress made in European governance and the tools available to the authorities to prevent contagion. Still, the difficulties that the Greek authorities are having in designing and implementing the necessary reforms and the uncertainty surrounding the outcome of their prolonged negotiations with European institutions and with the International Monetary Fund are fuelling grave tensions that could prove destabilizing. Monetary policy cannot guarantee strong and lasting growth on its own. In the short term, demand can draw support from a reasonable use of existing flexibility within the limits of European budgetary rules. As the European Commission too has said, a contribution could come from the countries with the smallest debt and soundest public finances. The Investment Plan for Europe must be implemented without delay. Broader action would require an autonomous fiscal capacity for the euro area. Going forward, this capacity could be achieved by introducing built-in business cycle stabilizers, a first step towards true fiscal union. In the medium term the creation of new income, new demand, and new jobs must be supported by measures and reforms designed, as of now, to raise productivity and growth potential. Technological progress brings about a marked expansion in activities that require expertise and new skills, but it can reduce, even considerably, the scope for employment in the sectors most susceptible to automation and to the growth of the digital economy. These consequences can be mitigated by developing new occupations, even in traditional sectors, that are less amenable candidates for automation. But investment is needed in infrastructure, education and training, and steps must be taken to make the labour market more efficient and minimize the fall-out for individual workers during the transition period. The support that monetary policy provides to aggregate demand is not an alternative to reform but it makes it possible to speed up the process and more easily absorb the short-term costs. The Italian economy: consolidating the recovery The recovery has now begun in Italy as well, albeit on a weaker basis than in the euro area as a whole. The expansion of exports has been accompanied by a recovery in domestic demand. The acceleration of household spending continues, especially on durable goods, mainly thanks to the improved outlook for disposable income. Investment returned to growth, and business surveys indicate that it could strengthen during the year. The increase in GDP in the first quarter ended a long period of unfavourable cyclical conditions; output is expected to continue to expand in this quarter and in those to come. A return to stable growth that can provide new job opportunities requires a continuing drive for innovation, which is necessary to adapt to new technologies and global competition. Progress on this front in the last few years has helped restore Italy’s balance-of-payments surplus on current account, which came to almost 2 per cent of GDP in 2014. Since 2010 the overall adjustment has exceeded 5 percentage points, reflecting cyclical effects as much as structural adjustments. Italian firms’ renewed capacity to compete is signalled by growth in the volume of goods exports that is greater than that in demand on our outlet markets, in particular those outside the euro area. The performance of the most efficient businesses that have increased their sales abroad, made investments and innovated, contrasts with that of a considerable part of the productive economy, which is characterized by a low propensity to innovate and more traditional organization and management. There is less innovative activity in Italy than in the other major advanced economies, particularly in the private sector. The latest European survey on innovation indicates that the lag, especially marked in comparison with Germany, is more noticeable in the high-tech BIS central bankers’ speeches industries. Italian firms have much less capability for in-house research and development and for cooperation with universities and other advanced training institutions. Compared with those in other advanced countries, firms in Italy not only start out smaller but also struggle to expand; even when they are successful they expand their work force more slowly and for a shorter period. As we have often noted, apart from the financial limitations that I will discuss later on, the barriers to firms’ activity and growth are mainly to be found in the environment in which economic activity takes place. The complex regulatory system, the relative inefficiency of public procedures and government action, the slowness of the justice system, and shortcomings in education and training all hinder the reallocation of productive resources to the most efficient firms, which is one of the main mechanisms of productivity growth. This situation is aggravated by corruption and, in several areas, the presence of organized crime. In the last two years there has been a significant recovery in foreign capital inflows for portfolio investment, including bank and corporate equity and bonds. Nevertheless, the barriers to the renewal and expansion of Italian firms continue to discourage direct investment in Italy. Such investment is an important factor for change in management, for innovation, and for productive and commercial positioning within international networks. Despite signs of vitality, foreign direct investment in Italy is modest by international standards. Reforms to remove the barriers to Italy’s development have been undertaken and have gained recognition from international institutions and markets. In order not to disappoint the expectations of change, the spectrum of the reforms must be broadened and their implementation accelerated. In some cases, the benefits will not be immediate, but this is all the more reason to act without delay, pursuing a comprehensive design. The recent labour market reforms have extended the income support mechanisms for the unemployed and, for newly hired workers, reduced the disincentive to permanent hiring connected with uncertainty over the outcome of decisions to terminate employment contracts. A full evaluation of the effects of these measures is premature. Trends in employment still reflect weak demand and ample unutilized production capacity. The sharp rise in new permanent contracts at the start of 2015, partly encouraged by the substantial tax relief in force from January, is a positive sign, suggesting that as the recovery takes hold, employment may grow and be oriented towards more stable forms. There is still the risk, however, especially in the South, that the recovery will not be able to create jobs to the same extent as in the exits from past recessions. The crisis came on top of the great transformation dictated by technological progress and increased integration between different economies, with the large emerging countries among the protagonists. Labour demand from the most innovative firms may not be sufficient to reabsorb all the unemployment in the short term. This would affect the very sustainability of the recovery since domestic demand would not fuel it sufficiently. This risk must be countered by supporting, including with innovation, activity in sectors where Italy has important traditions but also serious shortcomings and where production still depends on substantial inputs of labour, diversified according to skills and knowledge. Greater attention and greater public and private investment in urban modernization, land and landscape protection, and the exploitation of our cultural heritage can bring important benefits, combining innovation and employment, and not only in such directly involved sectors as construction and tourism. In this delicate phase, special importance attaches to the full integration of the active and passive labour policies outlined in the enabling act for labour market reform. It will be easier to keep pace with technological innovation if the requisite skills can be acquired through effective retraining and if income support allows the unemployed to undertake such retraining with dignity. As regards young people, schools must provide the prospect of a reasonable return, not exclusively economic, on their investment in knowledge. For some time many BIS central bankers’ speeches indicators have shown that Italy lags behind in both educational attainment and skills. To improve the curriculum, enhance quality and channel resources to where they are needed, requires first of all a systematic and in-depth assessment of the services provided and the knowledge and skills acquired. Our Annual Report, with its new format and content, this year includes an in-depth examination of the public administration. Our business opinion surveys clearly show that there are difficulties stemming from an excess of bureaucratic requirements and an unstable regulatory framework. International comparisons place us quite far down the rankings, even if in every part of Italy backward and virtuous situations coexist. The renewal of the public administration, which began several years ago and is one of the Government’s explicit objectives, is also the condition for carrying out a review of public spending that can preserve and improve the quality of services. In a situation that remains difficult, fiscal policy has sought to balance rigour with support to the economy, in accordance with the margins for flexibility allowed under the European rules, while keeping the deficit under 3 per cent of GDP in recent years. Following the severely restrictive measures necessitated by the crisis of confidence in 2011, it has been proper to dose fiscal consolidation measures carefully so as not to hinder the recovery. Thanks in part to the reform of the public pension system, in Italy more than in other European countries the long-term sustainability of the public finances can be preserved. Nevertheless, since the onset of the financial crisis the debt-to-GDP ratio has risen by more than 30 percentage points to 132 per cent, owing above all to the lack of economic growth. A return to higher levels of growth of nominal income, together with still prudent fiscal policy, will make the rapid reduction of the debt ratio possible. Banks and the financing of the economy The global financial crisis and its repercussions on the economy have prompted a widespread revision of the rules governing the financial system at international level. Vigorous measures have been taken both in the sphere of banking supervision and at macroprudential level with a view to restoring and preserving financial stability. In the euro area, Banking Union has been set in train rapidly after a discussion of the essential points between the European institutions and the governments of the member countries. In Italy, measures have been adopted or are being studied to strengthen the banking system, debilitated by the long recession, and enable it to support the recovery of the real economy. In the past months Parliament has reformed the cooperative banking sector. The biggest cooperative banks have long outgrown the confines of local markets. Like the other large Italian banks, they are now facing the changes imposed by economic integration and by technology. The cooperative form has deterred assessment of these banks by investors and impeded their ability to access the capital market swiftly, a crucial factor at times for coping with external shocks. The reform will facilitate efficient credit intermediation in a market made more competitive by Banking Union. The need for the banking foundations to perform their role of shareholder while respecting the investee banks’ management autonomy and to diversify their investments is a point that the Bank of Italy has stressed for some time. The Memorandum of Understanding between the Ministry of Economy and Finance, responsible for supervising the foundations, and the Association of Banking Foundations and Savings Banks is a step in this direction. The concentration limit on investment in a single issuer protects the interests of both the foundations and the banks. The Memorandum safeguards compliance with the ban on control, including joint or de facto control, of investee banks. It also improves the quality of governing bodies, increasing their degree of independence. BIS central bankers’ speeches For mutual banks to be able to continue to support their local markets and communities, preserving the spirit of mutualism that is their hallmark, it is necessary to pursue forms of integration based on membership of banking groups. Scant diversification of risk and the difficulty of capital strengthening are creating crisis situations in more than a few cases. The mutual banks’ trade association is drafting concrete proposals that will be evaluated in the light of their ability to remove the obstacles to recapitalization and to resolve these banks’ problems. Change cannot be delayed. Signs of improvement in the credit market are emerging. The flow of new loans has been growing since the closing months of 2014; in March the twelve-month decline in bank lending to firms was 2.2 per cent, a sharp abatement of the contraction that we have been witnessing for three years. Italian banks’ ample recourse to the targeted longer-term refinancing operations and the start of government bond purchases by the Eurosystem have permitted a significant reduction in the cost of bank funding and led to a gradual improvement in that of credit. The interest rates on new loans to firms have come down by more than a percentage point since the beginning of last year; the spread with respect to German and French rates has more than halved compared with the peaks of two years ago. In the course of 2014 the decline in interest rates, which until then had been confined almost exclusively to exporting firms and larger companies, began to involve firms operating on the domestic market and smaller enterprises. Credit conditions nevertheless continue to be uneven. In the sectors of the economy where economic prospects have already improved, lending to firms with sound finances has begun to grow again. In those where recovery is proceeding more slowly, and especially in construction, credit is still contracting. In the first quarter of this year the loan quality and the profitability of the largest banking groups showed signs of improvement, but the legacy of the recession still weighs on banks’ balance sheets. At the end of 2014 the stock of bad debts approached €200 billion, equal to 10 per cent of credit outstanding; other non-performing loans amounted to €150 billion, 7.7 per cent of loans. Before the crisis, in 2008, the overall ratio of non-performing loans was 6 per cent. Against these exposures banks have set aside substantial resources; they are making write-downs which absorb most of their operating profit and crimp self-financing. The upshot is a constraint on new lending. The large stock of non-performing loans also reflects the very long and variable duration of insolvency and credit recovery procedures, due in turn to the country’s cumbersome civil justice system. These widespread inefficiencies depress potential buyers’ valuations of impaired assets and discourage their sale on the market. The unfavourable tax treatment of loan loss provisions, though mitigated, still does not allow their immediate deduction from taxable income, as happens instead in the other main European countries; this determines an accumulation of deferred tax assets. Measures are being drafted to eliminate these competitive disadvantages, which weaken the Italian banking system. The development of a secondary market in non-performing loans, which is practically nonexistent at present, would contribute to fully reactivating the financing of households and firms. For some time we have been proposing initiatives along these lines, with scope for public-sector participation. We are working together with the Government to design them, in compliance with the European rules on state aid. A discussion that we hope will be rapid and constructive is now under way with the European authorities. In 2014 the large increase in Italian banks’ capital ratios, with the average core capital ratio rising to 11.8 per cent from 10.5 per cent the year before, was achieved mainly with the capital increases carried out, at our prompting, in the first half of the year; the contribution of self-financing was negative for the system as a whole. In order to recoup profitability, banks can curb costs further and expand their sources of income. More than a few banks, especially medium-sized ones, are evaluating mergers and acquisitions, including in response to recent regulatory innovations. There are sizeable potential BIS central bankers’ speeches benefits of these operations but they cannot be taken for granted; they require vigorous action at the organizational level, in rationalizing distribution systems, risk management and technology uptake. The revision of international prudential standards aims to protect the integrity of the banking system as a fundamental infrastructure for the functioning of a modern market economy. The new rules on capital, leverage and liquidity and the establishment of crisis resolution mechanisms will make the system more stable and lessen the possible effects of bank crises on the economy and the public finances. At the same time, they will result in a reduction of banks’ capacity to take risks and a structural reduction in the return on capital invested in them. The granting of loans will become more selective; the development, within a welldefined regulatory framework, of alternative forms of financing necessary to avert a shortage of resources for the real economy will have to be stimulated. Looking ahead, the shift of a part of the intermediation process from banks to markets will benefit both firms and households, allowing the former to expand their sources of financing and the latter to diversify their savings to a greater extent. Banks will continue to play a central role in the financial system if they prove able to accompany this evolution by expanding their activity in the field of services and assisting firms in direct capital raising. A trend of this kind is under way in many countries, but here in Italy the transition will not be easy. The underdevelopment of the Italian capital market reflects the characteristics of the structure of the economy and the consequent difficulties of assessing the risks and opportunities of financial investments. Banks’ leverage, measured as the ratio of total liabilities to own funds, is declining in all the major countries. In the United States, that of the ten largest banks has been halved since 2007; the effects on the overall financing of the economy have been limited, thanks to the contribution of the markets; bonds account for more than 40 per cent of firms’ borrowing. Banks’ leverage has also fallen sharply in the euro area, as a result of both capital increases and the contraction in credit. Since 2007 loans to firms have diminished in relation to GDP by five percentage points, to 42 per cent. The compensatory possibilities offered by the financial market are modest: at the end of 2014 bonds accounted for just over 10 per cent of firms’ financial debt. Failing a marked increase in their self-financing capacity, an overly rapid deleveraging of banks’ balance sheets would end up having procyclical effects on the economy, threatening to create a vicious circle between the reduction of credit and the erosion of productive activity. The construction of a diversified system that can offer the economy the necessary financial support – not in the shadows but in full transparency – cannot be deferred. The European Commission has put forward proposals for the creation of a Capital Markets Union by 2019. The proposed reforms aim at removing the obstacles to equity and debt capital raising, especially on the part of small and medium-sized enterprises and across borders. The success of the initiative requires that progress also be made in the harmonization of company, bankruptcy and tax laws. In Italy, important measures have been taken to strengthen the capital market. Equity issuance by firms has been encouraged by mostly eliminating the tax advantages of debt financing. Tax benefits have also been introduced for stock-exchange listing and for venture capital funds, along with incentives for bond issuance by unlisted companies. The possibility of making loans has been extended to insurance companies, and credit funds have been regulated. An additional contribution will come from the reform of non-bank financial intermediation, implementation of which is at an advanced stage. The results of these measures are positive, but much work remains to be done, including in the field of financial information and education. BIS central bankers’ speeches Supervision and Banking Union The Single Supervisory Mechanism became operational on 4 November 2014. Its launch was preceded by the comprehensive assessment of the balance sheets of the euro-area’s largest banking groups, which was designed to increase transparency and confidence. It was the first test of the new system, requiring a close comparison of national supervisory practices and cultures. The results confirmed the Italian banking system’s overall resilience to extreme shocks, even though it had received no significant state support during the crisis. The adverse scenario hypothesized in the stress test found capital shortfalls at two Italian banks under scrutiny by the Bank of Italy for some time, both of which are now carrying out capital strengthening plans. Given the institutional complexity of the new mechanism, the particularly tight deadlines for its construction, and the differences in national supervisory practices, the results to date are positive. The new supervisory system’s operating rules have been finalized, the decisionmaking mechanisms are being fine-tuned, and the 2015 supervisory programme, agreed in common for the first time, is being implemented. The pooling of experience and know-how will take time, requiring profitable cooperation and openness to discussion at every level. In recent months work has begun on several major projects; special importance attaches to the review of banks’ assessments of asset risk based on internal models previously validated by the national authorities. The aim of the exercise is to ensure consistent risk assessment and the accurate measurement of RWAs. The Basel Committee is also taking steps to enhance the transparency and comparability of internal models. The Bank of Italy supports these objectives fully. The capital targets notified by the ECB to the area’s significant banks in February, following the prudential review in 2014, were broadly based on the outcome of last year’s comprehensive assessment. The criteria for establishing banks’ capital objectives in the future are now being defined. In this phase of still uncertain recovery, the primary requirement of guaranteeing the solidity of individual institutions must be met without undermining their overall ability to supply credit to the economy. The euro area’s Single Resolution Mechanism will become operational in 2016, heralding important changes and with repercussions for the laws and practices governing crisis management, which have differed markedly between countries in the past. The mechanism will make use of the harmonized tools envisaged under the EU Bank Recovery and Resolution Directive, which implemented the international recommendations of the Financial Stability Board at European level. The mechanism has been designed to harmonize bank crisis resolution policies in the euro area, guarantee centralized crisis management for cross-border groups, and mitigate the risks associated with the failure of systemically important banks. Once up and running, it will make available common resources for the necessary interventions. As with supervision, tasks will be divided between the area’s Single Resolution Board and the national authorities in accordance with banks’ characteristics. A number of institutions will be involved in making decisions: the Commission, the European Council, the ECB, and national supervisory and resolution authorities. The complexity of the process calls for smooth and effective decision-making procedures. Any resolution of very big and complex banks will also require the preparation of an adequate backstop at European level that can be activated at short notice. It may also prove necessary to increase the resources of the Single Resolution Fund, which is financed by the banks. The inclusion of a bail-in provision in the Directive marks a radically new approach to resolving bank crises, whereby the necessary resources should be drawn first of all from the bank’s shareholders and creditors in order to keep costs down for the taxpayer. The aim is to prevent implicit state subsidies from becoming an incentive for opportunistic behaviour and to strengthen market discipline. Under this approach a wide range of bank liabilities could be bailed-in except, in particular, insured deposits and covered bonds. BIS central bankers’ speeches Investors must be made aware of the risks inherent in the new crisis management system, and customers, especially those less able to pinpoint these risks correctly, must be properly informed of the fact that if they hold instruments other than deposits and guaranteed liabilities, they may have to contribute to the resolution of a bank. In this new context, initiatives to restrict purchases of the riskiest instruments to professional investors may merit consideration. The time limit for transposing the Directive expired at the end of 2014 and the bail-in provisions must be incorporated into Italian law by 1 January 2016. These deadlines must be met as a matter of urgency: not just to avoid sanctions by European institutions but also because their transposition is essential to guarantee legal certainty and to enable the authorities to perform their new tasks using the tools assigned to them by European legislation. In this transitional phase, in which new tools cannot yet be used and the traditional mechanisms for intervention are being obstructed or made inoperable by European rules, resolving bank crises caused by recession or malfeasance has been made more difficult. We hope for the rapid passage of the enabling law now before Parliament in order for the Government to issue the necessary decrees to adapt Italy’s legislative framework to this new phase of Banking Union. * * * Economic regulation cannot ignore market mechanisms. Experience teaches that top-down directives are unlikely to hit upon the best paths of growth. There are cases in which public intervention does not work to the benefit of the community and distorts the allocation of resources. Wealth cannot be produced by law, nor can stable jobs be created. And budget constraints cannot be ignored except at the cost of severe damage. But where the market runs up against its limitations, regulators can and indeed must intervene, helping it to generate economic growth and employment. No market works efficiently or equitably without public institutions that enforce the rules of the game and guarantee legality and transparency. There can be no solid, balanced development without those collective works that the market, by itself, is incapable of supplying. These limits are perfectly well known to economic theory; the global crisis has brought them dramatically back to the forefront of our attention. In the financial sector, market failures are not infrequent. There are certainly abuses and predatory acts, which the authorities, including banking supervisors, must prevent as effectively as possible and sanction severely. There are also information asymmetries, problems of coordination of agents’ expectations, mechanisms that amplify price fluctuations and that may trigger euphoria or panic and in certain cases sever the link between prices and economic reality. At times prices can lose their essential function of guiding the allocation of resources, helping to orient the choices of consumers, firms and investors. Economic and financial governance requires accompanying the evolution of the market without bridling its force. There is no foolproof formula for striking this balance. Clear rules, impartially applied, are essential, but so is the ability to make sound and timely decisions in the light of circumstances. In Europe, public regulation and action in economic and financial affairs are now largely common matters, no longer reserved to single states. The transfers of sovereignty in this field, in part owing to the shock wave of the crisis, have been very substantial indeed; shared responsibility is increasingly the rule, not the exception. This applies to monetary policy, since last year it applies to banking supervision, and starting next year it will apply to bank resolution. Common policies regulate commerce, agriculture and fishing. Competition policy, with its rules, is an essential instrument for ensuring the proper working of the single market. The further integration advances and the more pressing and global the challenges become, the more the European Union’s governance capability must be strengthened. Steps ahead have been taken: rules, institutions, safety nets are being progressively placed in common. Although the path is not always straightforward, the progress made is undeniable and must continue. Within the Commission in particular, a technical core, the custodian of the common BIS central bankers’ speeches rules, coexists with the embryo of a politically responsible government. A synthesis must be found in the interests of the proper functioning of the internal market and the European economy. The authorities responsible for monetary policy and for banking supervision, whose independence from political institutions is sanctioned by the European rules, seek to strike a balance between rules and discretion: neither arbitrary power nor blinkered, acritical application of the rules. In the appropriate ways and at the opportune time, actions and decisions are made accountable. Attention is paid both to the inefficiencies of the State and to those of the market. In monetary policy, this explains recourse to unconventional measures; in banking supervision, it explains the effort to achieve an equilibrium – which does not mean laxity – between microprudential intervention at individual institutions and macroprudential considerations relating to the overall stability of the financial system. Substantial observance of the rules on market protection and equal competition remains indispensable. But in assessing the public role in the prevention and resolution of crises, and not only financial crises, greater consideration needs to be given to the characteristics that distinguish policies designed to activate market mechanisms from state aid that distorts competition. The national authorities, technical and political, are essential to the European decisionmaking process. It is up to each Member State to play its part in the common interest, not neglecting national interests and priorities but advancing them effectively within the European arena. In the difficult and sometimes tense debate between members, the voices best able to gain a hearing are those of the countries that are acting successfully at home and fully honouring their commitments. Let this be a spur to consolidate and extend the progress made, in Italy as in our common journey in Europe. BIS central bankers’ speeches | bank of italy | 2,015 | 5 |
Special address by Mr Ignazio Visco, Governor of the Bank of Italy, at the Launch of the OECD Business and Finance Outlook, Paris, 24 June 2015. | Ignazio Visco: Launch of the OECD Business and Finance Outlook Special address by Mr Ignazio Visco, Governor of the Bank of Italy, at the Launch of the OECD Business and Finance Outlook, Paris, 24 June 2015. * * * I first wish to thank the Secretary General for kindly inviting me here today. The OECD Business and Finance Outlook is a welcome newcomer that complements available analyses on the global economy’s macro-financial outlook published by international organizations. It adds, in this first issue, a distinct perspective by bringing together a number of topical issues that define the current situation of very low interest rates. I also like the focus on business investment and its financing channels in the post-crisis environment, and I agree on the relevance of the report’s key findings. Before learning more details from Adrian Blundell-Wignall’s presentation, I would like to offer just a few remarks, not least because the report’s starting point – record-low interest rates – is also very much affecting central banks’ actions in response to the global financial crisis and especially, in the euro area, the sovereign debt crisis. The Governing Council of the ECB has been confronted with the risks stemming from a prolonged period of exceptionally low inflation, if not outright deflation. These risks are considered particularly high in the current conditions of policy rates at historical lows, possibly marked disanchoring of inflation expectations, and high levels of public and private debt. The response has been to launch an expanded asset purchase programme designed to bring about a sustained adjustment in the path of inflation consistent with the return to price stability, that is an annual growth in consumer prices of below but close to 2 per cent in the medium term. Potential repercussions for specific sectors, such as those considered in the new OECD Outlook, are not being ignored. There are no signs, for the time being, that low interest rates are provoking generalized imbalances, or that asset and property prices are subject to particular speculative pressures. Local and sectoral tensions may occur, but they should be controlled with well-designed macro-prudential measures. Moreover, the exposure of institutional investors to a prolonged period of very low interest rates may be significant in some euro-area countries, but it should be limited through better matching between yields and duration of balance sheet assets and liabilities, improved operating results through portfolio diversification, augmented technical reserves, and the adjustment of contractual obligations to policyholders. In short, the risks, both real and financial, would have been far greater had we not taken the nonconventional measures in 2014 and early this year. The greatest threat to the euro area’s financial stability comes from the prospect of a combination of excessively low inflation and stagnating activity that the ECB programme aims to overcome. Indeed, there is, and not limited to the euro area as clearly observed in the Outlook, a substantial disconnect – the “greatest puzzle” of today’s global macro-financial setting – between a reluctance to take economic risk, resulting in the still subdued recovery of business investment, first and foremost in advanced countries, and a high propensity to take financial risk, as epitomized by high asset price valuations and compressed spreads. A better balance between financial and economic risk taking is the key to faster growth but it is itself fraught with risk. It rests mostly on complementary policies, including monetary and macroprudential ones, and especially on structural reforms that respond to the many challenges coming from a globalized environment and substantial changes in technology. The Outlook helps to shed light on a question we are all asking: how is it that today’s very favourable financing conditions have been little able thus far to foster a substantial recovery of business investment (which we all know is a precondition for growth and job creation). BIS central bankers’ speeches Uncertainty has long been identified as the main culprit, but the report adds value by highlighting the role played by such factors as strategies of multinational enterprises, participation in global value chains, and incentives to short-termism not only for companies but also for institutional investors. Here is where I find one of the report’s distinguishing features, a methodological one, namely that the analysis of the recent evolution of business investment is conducted using data on a large number of the world’s biggest corporations, thus complementing other analyses of a more macroeconomic nature. Also interesting is the contrast noted between the still subdued recovery of business investment in advanced economies and the signs of over-investment in the general industrial sector of many EMEs (not only China). By taking the current levels of low interest rates as a starting point, the report links this shortto medium-term feature with important longer-term themes such as population ageing and the sustainability of (public and private) pension and healthcare systems. New and old financial risks are appropriately discussed, risks generated by such key developments as the growing size and importance of institutional investors, their potential engagement in excessive search-for-yield, and the challenges to their longer-term financial soundness, including from longevity risk. Besides, the Outlook places a premium on the analysis of the impact of recent structural changes in the banking sector on the cost and availability of finance for growth. The analysis confirms that these changes, along with the more stringent international regulatory and supervisory framework for banks, are set to open up “bank lending gaps” outside the US, most notably for SMEs, while at the same time working as key drivers of regulatory arbitrage and the expansion of the “shadow” banking sector. This is an area where policymakers face a new trade-off: on the one hand, there is a need to develop alternative non-bank financing sources, chiefly for European SMEs; on the other, one should contain the distinct risks to financial stability posed by a growing shadow banking system, whose funding mechanisms are more prone to create leverage and counterparty exposures. These are issues on which there is substantial regulatory and policy attention, not least by the Financial Stability Board. It should lead to principles and practices that increase transparency and allow, especially in Europe, new direct and indirect ways for capital to flow towards promising investment projects. The Outlook calls for a two-pronged strategy of restoring banks’ health and developing alternative market-based sources of financing for investment, a prescription clearly in line with recent European initiatives. The challenge is to make it work, and we should all be engaged in this effort. In the European Union this means unifying, rapidly and wisely, our capital markets as well as helping sound and profitable cross-border financing to flow smoothly to the common benefit, without short-sighted barriers. But I also share the emphasis on the need to consider country-specific features when it comes to identifying approaches and instruments most appropriate to improve SME financing. The interdependence and counterparty risks in the financial sector are still being regarded in the Outlook as the greatest threat to financial stability. That this is still believed to be so is a sad conclusion, as it seems to imply that not much has been achieved since the eruption of the global financial crisis in terms of the regulatory set-up and the practice of policymaking. I only partly share this conclusion, as I believe that in many fields solid progress has been obtained. The report seems to link these risks mainly to the lack of a strong separation of regular retail banking from such activities as prime broking and custody and collateral management services. It goes as far as stating that “in this respect, the Volcker rule, Vickers and European legislation did not go far enough”. I am sure that more could be done in this field, and I look forward to it, but I would also like to warn against an excessively formal approach. The real challenge is to avoid conditions such as “too-big-to-fail” and “too-interconnected-to-fail”. I BIS central bankers’ speeches observe, in this respect, that the awareness and the strength of supervision (not only regulation) have much risen in recent years. Finally, I certainly subscribe to another of the report’s policy prescriptions for encouraging “compensating investment”, such as in R&D and social infrastructure, to offset the tendency of multinational enterprises to shift production, notably in the manufacturing sector, away from advanced economies, even if some reversal is currently occurring. And I cannot help but share the point made by Angel Gurría in his Editorial, that addressing the multifaceted long-term challenges posed by population ageing ultimately requires business investment, notably in R&D and innovation, that supports productivity and economic growth. Policymakers therefore need to ensure framework conditions that are most conducive to stronger capital formation. To conclude, identifying and monitoring old and new risks is a key ingredient for effective crisis prevention. The Business and Finance Outlook that the OECD is launching today promises to provide analysts and policymakers with an additional tool that offers distinctive but complementary perspectives with respect to other established, useful and time-honoured outlooks and reports, such as the OECD Economic Outlook, on which I spent so many hours over the years in this very location, with colleagues I will always remember with nostalgia and affection. BIS central bankers’ speeches | bank of italy | 2,015 | 7 |
Welcoming remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the T2S Launch Celebration, Milan, 2 July 2015. | Ignazio Visco: Translating a shared vision into a winning story Welcoming remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the T2S Launch Celebration, Milan, 2 July 2015. * * * Good afternoon. President Draghi, colleagues of the European Central Bank, of the European Parliament and the EU Commission, Ladies and Gentlemen, It is my pleasure and privilege to welcome you all here today, in Milan (the destination of the year, let me say in passing), to share this important moment: the launch of the TARGET2Securities platform. For the euro area and the Eurosystem, we are now living through what is, to say the least, a challenging period. This acknowledged, we must nonetheless recognize that T2S is a major achievement. This ambitious project is now reality thanks to the combined effort and cooperation of 21 countries - represented by their central banks, central securities depositories and financial market institutions - together with the European institutions: the ECB, the Parliament and the Commission. The T2S platform that has been built by four national central banks – Banca d’Italia, Deutsche Bundesbank, Banque de France, Banco de España (the so-called 4CBs) - is now in operation with a first group of securities depositories and their linked-in user communities for the settlement of securities transactions in euro. By February 2017, at the end of the migration period, the platform will be deployed across Europe, covering the vast majority of securities transactions in euro. The activities that took place over the migration weekend of 20-21 June ran smoothly. They were coordinated by the teams from the 4CBs and the ECB. Since the 22nd, Banca d’Italia and Bundesbank have had the responsibility for operating the platform. The T2S project was large and complex, involving many stakeholders. We have come a long way: from the start of the specification phase to the go-live, the project took seven years. The 4CBs, mandated by the Eurosystem, developed and implemented the platform. This has been a demanding task, one to which our institutions have devoted substantial resources. Aside from the role of developer and operator of T2S, the four central banks have been actively involved in the project through the participation in technical and steering structures with an important role in the governance of the platform. The participation of securities depositories in T2S is voluntary; it took almost two years of negotiations between the Eurosystem and the European CSD community to achieve a mutually satisfactory contract for the use of the platform’s settlement services. The broad participation in the governance of T2S ensured that all parties were given a voice in the project; the complex governance setup will be tested during the operational phase, when decisions will have to be taken swiftly and at times under stress. Why T2S after TARGET2? I imagine this topic will be addressed by the ECB President in his talk. For now, let me just briefly rehearse some of the efficiency gains that T2S will bring. First and foremost, lower fees. In fact, with T2S the cost of settling cross-border transactions in Europe will be lowered, and more appreciably so with the gradual increase in settlement volumes as migration proceeds. Second, T2S will greatly facilitate transfers of collateral, hence liquidity management. This has become a critical issue in recent years because of the increasing demand for collateral. Finally, T2S will contribute significantly to making settlement more reliable thanks to its extremely robust business continuity solution, based on the model already developed for TARGET2. The next important step will be accomplished at the end of August when the Italian CSD Monte Titoli and the Italian banking community bring their securities transactions to T2S for BIS central bankers’ speeches settlement. The Italian market will add operational complexity through a substantial number of transactions, averaging 100 billion euro a day and topping 200 billion on the days of issuance and redemption of government bonds. This requires paying the utmost attention to avoid even the minimal operational risk that may still be related to the many technical procedures of the platform. And this is the reason why Italian banks are now still actively testing the interaction of their internal IT procedures in the new environment. Banca d’Italia has the job of monitoring trials in the Italian market to ensure successful migration. We participate in the testing both as central bank and as customer of Monte Titoli, focusing on the issuance of Italian government bonds and the related financial services. Banca d’Italia also serves, jointly with Consob, as the supervisor of Monte Titoli. However, the challenges are not all behind us yet. Very substantial volumes are still to arrive, not only with Monte Titoli at the end of August but also with the major players in the second and third waves. We have to work hard for T2S to be a milestone in the process of building the Capital Market Union. Finally, I wish to thank the staff of the 4CBs and the ECB for their effort and their commitment to the project’s success: they have all been involved in the development of T2S and are now actively engaged in the operational phase. And thanks to all those involved central banks, CSDs, financial markets-for their unflagging support and decisive contributions. Once again, let me extend our welcome to everyone present. I wish you all a pleasant evening. BIS central bankers’ speeches | bank of italy | 2,015 | 7 |
Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the Annual Meeting of the Italian Banking Association, Rome, 8 July 2015. | Ignazio Visco: Recent economic and financial developments in Italy Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the Annual Meeting of the Italian Banking Association, Rome, 8 July 2015. * * * The breakdown of the negotiations between Greece and its international creditors and last Sunday’s referendum results have had a relatively modest impact, so far, on the euro area’s financial markets. Certainly, the availability of viable, credible European instruments for intervention has helped. The significant progress made in recent years by the other countries struck by the sovereign debt crisis has been important. However, future developments remain fraught with uncertainty: what is at issue in Greece is not just the public debt that has been accumulated but how to put the public finances back on a sustainable path and above all how to make the economy competitive and capable of growth. On a different scale, these are the same challenges that face the euro area as a whole. The day before yesterday the Governing Council of the ECB decided to keep the emergency liquidity assistance that the Bank of Greece can provide to the country’s banks at its current level. The Greek authorities extended the closure of the banks and the limits on cash withdrawals for two days, until this evening. Consultations between Greece and the European authorities are ongoing. The Governing Council is closely monitoring financial market developments and the implications for monetary conditions and price stability in the area; it stands prepared to deploy all the instruments available. Even in a worst-case scenario, the immediate impact of the Greek crisis through trade and financial channels would be modest for Italy and for the euro area. But the crisis may have more serious repercussions if it revives international investors’ fears that the euro may not be irreversible. In that case, coordinated countermeasures by both national and European authorities will be indispensable. To date the tensions have not significantly undercut the effects of the Eurosystem’s expanded asset purchase programme. The rise in long-term interest rates since the middle of April is largely the consequence of the improved prospects for inflation and growth, due in turn to the purchase programme itself, and possibly also of a correction of the initial overreaction. The Governing Council is determined to carry out the programme in full in order to bring inflation back into line with the medium-term objective. Any undesirable tightening of monetary conditions will be forcefully countered. Credit conditions and credit quality The monetary expansion is gradually being transmitted to credit conditions. In Italy the interest rates on new business loans and home mortgage loans were down to 2.2 and 2.7 per cent in May, from 3.1 and 3.3 per cent in mid-2014. For firms, the spread with respect to the corresponding German and French rates has narrowed by about half a percentage point. And since the middle of last year the improvement in credit cost conditions is no longer limited to the largest and financially soundest corporations. The contraction in lending to non-financial corporations has nearly ceased. In the three months ending in May the annualized decline came to half a percentage point, compared with a much faster decrease of around 3 per cent in the middle months of 2014. Lending to households has begun to grow again, if only modestly. The timing and strength of the upturn vary by sector and by individual firm. Lending to manufacturing and non-real-estate service firms that have no debt payment arrears has expanded, but credit to firms in construction and real-estate services, sectors where the overall risk remains high, is still diminishing. BIS central bankers’ speeches In the first quarter of the year the flow of new bad debts eased to 2.4 per cent of outstanding loans, from an average of 2.6 per cent in 2014 and 2.9 per cent in 2013. The improvement was due to loans to firms, for which the new bad debt rate fell by 0.6 points to 3.9 per cent. The decrease involved all sectors of economic activity. Credit quality remains poorer for construction firms and firms located in the South. At the end of March banking groups’ bad debts amounted to 10.2 per cent of outstanding loans and total non-performing exposures to 17.9 per cent. The large volume of nonperforming loans continues to restrain the supply of credit and puts Italian banks at a disadvantage with respect to their European counterparts. Apart from the long recession, it reflects constraints and rigidities that oblige Italian banks to keep impaired assets on their books much longer than banks in the other main countries. Measures taken by the Government last month will increase the speed and efficiency of bankruptcy procedures and property foreclosures. They make loan losses immediately tax deductible. In this way they act directly on some of the causes of Italian banks’ large stock of non-performing loans. Accurate assessment of the measures’ impact is hindered by the lack of official statistics on the length of the procedures involved. For bankruptcy procedures, market sources indicate an average duration of about six years. Preliminary estimates, which are subject to considerable uncertainty, suggest that in a favourable scenario this time could be halved, but a series of organizational and operational factors could reduce the effect. For foreclosures, the duration might be shortened, on average, from four to three years. Speeding up these procedures will have a positive effect on banks’ balance sheets. First of all, it should raise the market price of impaired assets. Some simulations show that a reduction of two years in credit recovery times could increase the value of collateralized nonperforming loans by as much as 10 per cent, and market estimates appear to be largely aligned with this valuation. Moreover, the stock of non-performing loans should shrink, by as much as half in the longer run. The measures taken by the Government include the immediate, rather than deferred, deductibility of write-downs and loan losses, so as to freeze the creation of new deferred tax assets in connection with loan loss provisions. The changeover to immediate deductibility eliminates a significant competitive disadvantage for Italian banks in the Banking Union, making it less onerous to write down loans when necessary, and it attenuates the procyclicality of their tax treatment. Deferred tax assets stemming from loan losses already entered in banks’ balance sheets, equal to around €25 billion, will be gradually reduced and will completely disappear over the next few years. The set of measures entails no cost to the State. All in all, these measures can, in time, lead to a significant reduction in the risk-weighted assets of Italian banks and make way for new loans capable of largely offsetting the lending reduction of recent years. But relieving banks’ balance sheets of the large stock of nonperforming loans will require action on a series of fronts, since the reasons for their existence are multiple. The value appreciation of non-performing loans brought about by the reform will spur the creation of a secondary market for these assets, but may not be enough to ensure this market is sufficiently large. This is the proper framework in which to view the planned creation of an asset management company specializing in the purchase of non-performing loans. On this front the dialogue between the Italian authorities and the European Commission is producing useful and necessary analyses. As I have clarified on other occasions, the project is designed to reactivate market mechanisms, not to remedy the difficulties of individual banks at taxpayers’ expense. It can also help restore an adequate flow of credit and thus support the economic recovery. BIS central bankers’ speeches The dialogue must be brought to a conclusion rapidly; protracted uncertainty over this matter can discourage the completion of market transactions. Banks must also take steps to improve the data on non-performing loans. The analyses on this subject have brought to light informational gaps that could dissuade potential buyers. Data are also needed in order to improve the banks’ own management of these assets. Banks’ corporate governance The reform of the cooperative banks is now in the implementation phase. The supervisory instructions issued by the Bank of Italy that complete the reform and enable the launch of the operations needed to ensure that cooperative banks with assets of above €8 billion comply with the new legislation came into effect on 27 June. Once it is ascertained that this threshold has been exceeded, the bank’s executive bodies must, within a given deadline, draw up and transmit a plan to the Bank of Italy listing the initiatives to be undertaken within the 18-month time limit envisaged by the law. In exercising its powers of authorization, the Bank of Italy will verify that the corporate operations proposed by the banks do not have the effect of perpetuating, under a new guise, the ownership and management arrangements that the law is meant to abrogate. Another important step that must be taken is the reform of the mutual banks. While the cooperative bank reform takes account of the emergence of large, often listed, banks whose original links to their local communities had been severed, in the case of mutual banks the issue instead is to create the conditions for them to continue to fulfill their specific function, even in the current context, maintaining their mutualistic connotations and local community links. Integration in banking groups is needed to favour access to capital markets in view of high credit risks, as well as to improve the quality of management, increase efficiency and keep costs down. This would not constitute a diversion from the mutual banks’ original purposes but on the contrary would strengthen their ability to serve their members and their communities, among other things by providing a broader range of services adapted to their customers’ needs. The completion of the reform will necessitate legislative interventions that promote forms of integration based on membership of banking groups, based on models that have been adopted in other European countries. The Bank of Italy is monitoring the discussion on these issues and is engaged in dialogue with the competent institutions. Our hope is that shared solutions can be arrived at, capable of guaranteeing these banks’ continued presence on the market. Supervision and crisis management In this phase the Single Supervisory Mechanism, in operation since November, is acting to ensure that the playing field in which the supervised banks do business is as level as possible. Initiatives to review the ways in which banks that adopt internal models measure their risk-weighted assets can contribute to the attainment of this objective. The analyses conducted by the supervisory authorities at international level demonstrate, in fact, that differences in the riskiness of bank portfolios do not fully account for the differences found in the way the various banks’ capital requirements are quantified. Significant changes are being made to the legal framework for managing bank crises. At European level plans are being prepared for the resolution of possible banking crises. Last week the Italian Parliament approved the enabling law for the transposition of the Bank Recovery and Resolution Directive (BRRD), to be completed by the promulgation of the mandated legislative decrees. The Bank of Italy has been designated as the Italian resolution authority, and we will shortly make the organizational changes required for the most effective performance of these functions. BIS central bankers’ speeches Under the new European rules, if supervisory interventions cannot prevent the failure of a bank, the resolution authority must consider whether to follow the ordinary insolvency procedure – under Italian law this means compulsory administrative liquidation – or whether instead it would serve the public interest to initiate the special resolution procedure in order to maintain systemic stability, while holding public support to a minimum and protecting depositors and customers in general. The European Commission’s 2013 Communication on the application of the state aid guidelines already foresees the involvement of a bank’s shareholders and subordinated creditors before any public support is provided. With the transposition of the BRRD, regardless of possible public intervention, shareholders and holders of capital instruments will be called on to contribute to resolution. Starting next year, what is more, a bank’s senior creditors can also be “bailed-in”. Deposits up to €100,000 will continue to be fully protected by the national guarantee schemes, which have been reviewed at European level to harmonize levels of coverage and to ensure that they have adequate and readily available funds. In any case deposits beyond €100,000 held by individuals and by small and mediumsized enterprises will receive preferential treatment in respect of other instruments. In placing their securities, the banks must be especially careful to comply with the investor protection rules, since subscribers may be called on to contribute to the resolution costs. Customers must be given exhaustive information on the characteristics of the different instruments, the riskiest of which should be expressly reserved to institutional investors only. Today the Bank of Italy, as part of its financial education programme, has posted on its website an account of the rules that will soon enter into force in our country. With the implementation of the BRRD, under the Single Resolution Mechanism for banking crises, a Single Resolution Fund will be established, to which euro-area banks will progressively transfer resources to finance resolution procedures. In particular circumstances, such as when the bail-in might entail risks for financial stability or compromise the continuity of critical functions, the authorities may, at their own discretion, exempt some categories of creditors from their obligation to contribute to the costs of the resolution. A backstop at European level still has to be designed, using public money to supplement the resources of the Single Resolution Fund in order to deal promptly with any crises involving the largest banks. The recent report by the “five presidents” on Completing Europe’s Economic and Monetary Union indicates, opportunely, that such a backstop is a priority, along with a comprehensive single deposit guarantee scheme that goes beyond the mere harmonization of national schemes. The capital market and finance to the economy The capability of the banks to take on risks has diminished and they have become more selective as regards borrowers. We need a more diversified financial system if we want to support investment and economic growth. Some signs of change have emerged. New stock market listings are increasing, there is a growing volume of bond issues, including by medium-sized firms, the number of mini-bond issuers is rising, and the average volume of issues is declining. This last year has seen the introduction of various funds geared to investment in the debt instruments of small and medium-sized enterprises: at the end of June there were 23 such funds under the aegis of Italian asset management companies, 15 of them already operational. Other funds have been instituted by foreign managers. However, the capital raised by the Italian funds is still scanty – under €2 billion. These changes, which stem partly from firms’ difficulty in obtaining bank credit, were encouraged by public interventions, such as tax incentives for capital increases and the new rules on bond issues by unlisted companies. Direct funding to the private sector, in the form BIS central bankers’ speeches of shares, bonds and loans, is still relatively small: these instruments account for just 16 per cent of the financial assets of insurance companies and pension funds in Italy, compared with 23 per cent in the euro area as a whole. Nevertheless, even a more favourable regulatory environment may not be enough to induce investors to diversify their assets, although the decline in the returns on traditional instruments has encouraged the search for higher yields. Investment in securities issued by firms, typically riskier and relatively illiquid, calls for specific professional skills. Many investors lack these skills and thus need services and infrastructures to acquire and analyse the information necessary for risk assessment; they also need specialized funds to which to entrust their assets, and financial instruments for the efficient diversification of risks and profit opportunities. Closer financial market integration at the European level is essential for the development of new financial instruments. This is the aim of the proposal of the European Commission, which in February presented a green paper on building a capital markets union in the EU by the end of 2019. The suggested reforms are intended to overcome the obstacles to raising risk capital and debt capital, particularly for small and medium-sized enterprises; they may also help to support asset diversification by institutional investors. The finance ministers have asked the Commission to submit a detailed plan of action by the end of September of this year. In the short term, the priorities are to simplify the prospectus directive, making it easier for firms, especially small and medium-sized ones, to obtain listing; to standardize information on credit quality; to develop a market for simple and transparent securitizations, possibly subject to favourable prudential treatment; and to create a European private placement market, a form of financing that allows firms to place their bonds with one or more institutional investors at a lower cost than that of issuing securities to the public. Over a longer period, for full capital markets union the various countries’ company and bankruptcy legislation needs to be harmonized and the differences between the tax treatment of capital gains reduced, notably as regards the method of calculating the tax base. Legislative harmonization will be a gradual process; it will therefore be best to follow a modular approach, starting with the easiest reforms and then gauging where there is room to tackle more ambitious challenges. The project is of major importance for Italy. The creation of broad and efficient markets would offer firms, even the smallest of them, new opportunities for borrowing and for growth and investors a wider array of options. The issues of establishing credit ratings and standardizing corporate information are especially important. The availability of private placement in Italy would be extremely useful, particularly for small and medium-sized firms, which have very limited access to the bond market at present. Its development in Italy too will be furthered by standardizing the rules and practices at European level. * * * The lengthy, and still unresolved, Greek crisis has cast new light on the limits still encumbering the governance of the Economic and Monetary Union despite the efforts of recent years. The stability of the Union cannot be undermined by one country’s difficulties. If a member state finds itself in a financially untenable position, then there must be the means to arrive at a rapid and orderly solution. In strengthening European integration, not only in the economic sphere, effective methods of handling emergencies must be identified and adopted. Ultimately, in order to absorb cyclical and structural shocks the euro area must have a common budget, based on autonomous taxation capabilities and direct recourse to financial markets. The resilience of member states’ economies can be improved by introducing institutions that facilitate labour mobility BIS central bankers’ speeches and by making more rapid progress towards unifying the capital markets. The ability of national budgets to counter adverse cyclical phases must also be safeguarded. Individual countries must continue their efforts to enhance the soundness and the growth potential of their economies. Italy has taken several important steps that are now beginning to bear fruit. Had we not done so, the Greek crisis would have had serious repercussions. But our task is not complete; reform must continue in all sectors of the economy and in the public administration. Our financial system must become more competitive and regain its capacity to fully support economic activity. The measures bearing on the quality of credit and the governance of banks constitute a major advance in this direction. BIS central bankers’ speeches | bank of italy | 2,015 | 7 |
Keynote address by Mr Ignazio Visco, Governor of the Bank of Italy, at the Euromoney - The Italy Conference, Milan, 15 September 2015. | Ignazio Visco: Advancing European financial integration Keynote address by Mr Ignazio Visco, Governor of the Bank of Italy, at the Euromoney – The Italy Conference, Milan, 15 September 2015. * * * I would like first of all to thank Euromoney for inviting me today and I wish a warm welcome to all participants. The conference program is ambitious, spanning from the European economic outlook to key issues for Italy such as public debt, competitiveness, structural reforms and the banking system. I will start by briefly reviewing some of the most recent economic developments. I will then offer some thoughts on the objective of advancing the integration of European financial markets. Indeed, beyond the current cyclical developments, completing the Banking Union and diversifying the sources of financing for households and non-financial firms by setting up a Capital Markets Union remain the priorities to deepen European financial integration, foster higher and more sustained growth and help prevent the repetition of crises whose very high economic and social costs we are still having to face. The economic outlook and the ECB monetary policy The growth recovery in advanced economies is facing the impact of a further slowdown in emerging market economies, hit by declining commodity prices, less favourable external financing conditions and a sudden reassessment of China’s growth prospects and subsequent global repercussions. Slower growth in advanced economies in the first half of the year reflected weakened exports and a deceleration in domestic demand. Since the summer, the major correction in Chinese equity markets has triggered a wave of volatility in global financial markets and a renewed drop in commodity prices. Weakening foreign demand is not just a major concern for exports but can also endanger the tentative recovery of investment, which hinges on the prospects for trade. Further downward pressures on oil and other commodity prices, on top of other supply factors, may also push down inflation and inflation expectations, raising real interest rates. Global financial markets are also being conditioned by the expectation that the first increase in the federal funds rate is approaching, which would reflect a further strengthening of the US economy. Financial conditions in advanced economies remain accommodative nevertheless and a modest pickup in growth is projected by the IMF this year and in 2016. In the euro area, the economic recovery is expected to continue, albeit, perhaps, at a weaker pace. Growth is also being held back by the process of balance sheet adjustment that is still undergoing across a number of sectors. But the ECB asset purchase programme exerts a positive impact on the cost and availability of credit for firms and households. Recent sharp fluctuations in financial and commodity markets are under close monitoring in order to assess their possible impact on the outlook for prices. At its meeting of September 3 the ECB Governing Council recalled that the programme provides sufficient flexibility in terms of adjusting its size, composition and duration; it reaffirmed its willingness and ability to act, by using all the instruments available within its mandate, if necessary, in particular to counter an unwarranted tightening of monetary conditions or a material worsening of the inflation outlook. In Italy, the recovery is expected to proceed at a moderate pace. More favourable financing conditions, following the very easy monetary policy stance that has resulted from the decisions progressively taken since the summer of last year, and increased confidence would finally also support domestic demand and capital accumulation. Private consumption should also benefit from lower oil prices and stronger household income, boosted by government’s measures and by the improvements in labour market conditions. Recent data BIS central bankers’ speeches on economic activity and households’ spending go in the direction of confirming the overall improvement in growth prospects. Credit conditions and credit quality Credit conditions in the euro area continued to improve, albeit slowly, reflecting an easing in credit standards as well as an increase in loan demand. In July, both the annual growth rates of loans to households and non-financial corporations increased to 1.9 per cent and 0.9 per cent, respectively, while heterogeneity of credit conditions across countries has narrowed. In Italy, credit demand among firms is picking up for the first time since 2011, while demand among households has also strengthened. However, both credit conditions and loan dynamics remain heterogeneous across sectors of economic activity. According to the Bank Lending Survey for the second quarter of 2015, Italian banks kept easing credit standards for both firms and households, as balance sheet and liquidity conditions have improved and competition among banks has increased. As a result, in July the 3-month annualized growth rate of loans to firms turned positive (0.7 per cent, from –0.2 per cent) for the first time since November 2011 and the growth rate of credit to households further increased. However, despite improvements prompted by monetary policy measures, bank credit in the euro area remains subdued, partly as a consequence of high levels of non-performing loans (NPLs). This is especially the case for Italy, where the volume of non-performing loans (NPLs) has trebled since the start of the global crisis, largely due to the major fall in economic activity (close to 10 per cent for GDP and 25 per cent for industrial production). It also reflects structural problems, including an inefficient legal system and particular features of the tax system. As a result, a lasting solution to the NPL problem requires a comprehensive strategy: removing the inefficiencies plaguing the bankruptcy and foreclosure system that prevent a faster recovery of credit as well as kick-starting the markets for NPLs. In August, the Italian government passed a law with two sets of key measures. A first set amends the insolvency and foreclosure system. These new measures will reduce the length of legal proceedings and increase the recovery rate of creditors’ claims. A second set of measures allows for the immediate, rather than deferred, fiscal deductibility of banks’ write-downs and loan losses, aligning the Italian fiscal rules to those prevailing in the main euro area countries. These new provisions put an end to the long-standing regime of deferred deductibility of loan losses, which created disincentives for banks to provision; as a consequence, no new deferred tax assets in connection with loan loss provisions will be created. As these measures address some of the root causes of the high stock of NPLs, they are expected to have positive effects on NPL prices, further reducing the price gap between banks and potential buyers and helping the development of a secondary market for these loans. However, this market is still extremely thin and opaque; prices may not be fairly determined. The launch of an Asset Management Company (AMC), which would buy NPLs (specifically “bad loans”) from banks, would contribute to kick start the market for NPLs, increase the transparency of banks’ assets and improve the conditions at which they raise capital and funding. The AMC would be different from similar vehicles set up in other countries, where banks were in a state of crisis and were forced to participate. First, in Italy the project is aimed at solvent banks, hence participation would have to be voluntary. Second, unlike previous cases, its design would have to be such that assets are transferred at market prices. This rules out a transfer of losses from the banks to the State, which would trigger the consequences of the European State-aid regulation. These important differences substantially increase the complexity of the scheme, whose feasibility is still being studied. This is the object of the current interaction with the European Commission. BIS central bankers’ speeches European financial integration and the crisis Ongoing efforts on several fronts to fully restore the functioning of credit markets in the euro area are relevant not only to support growth via an adequate flow of credit but also, from a central bank’s perspective, because diversified and integrated financial markets help to improve the smooth and uniform transmission of monetary policy. Following the introduction of the common currency in 1999, European financial integration achieved remarkable progress, most notably in those market segments that are closer to the single monetary policy, but also in markets for government and corporate bonds. The unsecured money market, a key segment of interbank markets, had reached a stage of “near-perfect” integration almost immediately after the adoption of the euro. The standard deviation of the EONIA lending rates across euro area countries had fallen sharply to close to zero and had remained stable until the beginning of the global financial crisis in July 2007. The global and euro area sovereign debt crisis provoked a sudden reversal of this progress. Reflecting the incompleteness of the euro project, “redenomination” risks materialized through very high credit and sovereign spreads, undoing financial integration and replacing it with financial fragmentation along national lines, which came to represent a hallmark of the euro area crisis. Over the last three years or so, the European response has brought financial integration back to a level comparable to pre-sovereign debt crisis levels, although some fragmentation still remains. A comprehensive monetary policy response, national efforts towards fiscal consolidation, a reinforcement of euro area banks’ balance sheets and major reforms of the European economic governance, most notably the launch of the Banking Union, have eased financial conditions and greatly reduced financial fragmentation. The Banking Union Banks remain the backbone of the euro area financial system: their health is paramount in effectively providing financing for firms, notably small- and medium-sized enterprises, and for the economy as a whole. The Banking Union is a landmark step towards deeper financial integration. Its first pillar, the Single Supervisory Mechanism (SSM), has been up and running since November 2014. Drawing on the EU single rulebook, it provides a euro-area approach to supervision, as well as better monitoring of cross-border banking groups. The ECB has also been equipped with new macroprudential powers and tools that may complement instruments available to national competent authorities in addressing systemic risks, such as those that may arise from the procyclicality of credit supply, a key driver of many detrimental boom-bust cycles. The benefits of the SSM became visible even before it came in operation. The comprehensive assessment that preceded it has stimulated a substantial strengthening of euro area banks’ balance sheets, setting the preconditions for their renewed ability to adequately finance the economy. The ECB and the national supervisors are working to gradually remove national discretions and heterogeneities. The final objective should be to further foster financial integration so that banks operate in a full level playing field. The Single Resolution Mechanism (SRM), the second pillar of the Banking Union, will be fully in place as of January 2016. Ensuring the timely and effective resolution of failed banks is a crucial component of a stable financial system. By promoting better crisis resolution, the SRM will also improve market discipline and reduce excessive risk-taking. The SRM will make use of the harmonized tools provided by the EU Bank Recovery and Resolution Directive. The inclusion of a bail-in provision in the Directive marks a radically new approach to resolving bank crises, whereby the necessary resources should be drawn first of all from the bank’s shareholders and creditors in order to avoid or minimize potential costs for the taxpayers. Let me recall that bank deposits protected by the deposit insurance BIS central bankers’ speeches system are excluded from bail in. Besides these deposits, other deposits held by individuals and by small- and medium- sized enterprises would receive preferential treatment with respect to other instruments. We are aware that the introduction of bail-in tools may have an impact on the banks’ funding costs. In addition, in placing their securities, banks must be most careful to comply with the investor protection rules, since subscribers may be called on to contribute to the resolution costs. Customers must be given exhaustive information on the characteristics of the different instruments, the riskiest of which should be expressly reserved solely to institutional investors. But resolution is just the final step when a financial institution is undergoing a crisis. Recovery is as, if not more, important. In order to avoid having to resort to resolution – or, should resolution become necessary, to make it efficient and avoid undermining the provision of important financial services – banks are required to be prepared in advance to confront stress, and must make recovery plans readily available – a set of actions that the bank itself would undertake in order to restore or maintain its viability and financial soundness. It is the responsibility of supervisory authorities to assess the quality and credibility of these recovery plans and to require their implementation as an early intervention measure. On the other hand, resolution authorities will draft resolution plans to identify the resolution strategy that best fits the organizational and operational structure of the bank and adopt measures to improve resolvability, where adjustments are required. Given the need to duly take into account the impact on the ongoing business and the stability of banks, supervisory and resolution authorities should cooperate closely in defining such measures. Finally, completing the Banking Union requires further steps, including the construction of its third pillar, the proposed European Deposit Insurance Scheme. A common, privately-funded scheme would be consistent with the main idea underpinning the Banking Union, i.e. that effective crisis management is in the best interest not only of the Member States in which banks operate but also of the euro area as a whole given the interconnections that characterize a financially integrated market. It is expected that the establishment of the Banking Union will foster structural changes in the European banking sector, for example consolidation via cross-border M&As. The structure of the sector might also be affected by the adoption of the European Commission’s proposal that sets limitations for the biggest and most complex banks in risky proprietary trading and the possibility for supervisors to require separation between certain potentially risky trading activities and deposit- taking business in case of threats to financial stability. Given the impact of the past financial crisis, measures to make the system more resilient are welcome and the structural measures add to the toolkit to address this objective. At the same time, a too-harsh design such as the outright ban on proprietary trading might have unintended consequences on the smooth functioning of markets; therefore, the milder European solution – separation, as opposed to an outright ban for proprietary trading – represents a balanced outcome. The Capital Markets Union and the complementarities between bank and market financing The crisis has not only underlined the need for revising and strengthening prudential regulation and aiming for higher standards of bank supervision but has also made evident the limits of a financial system that relies excessively on banks, thus highlighting the importance of diversifying the sources of financing. Going forward, capital markets and nonfinancial intermediaries will have to take on a larger role in financing investment and economic activity. This goal is even more important given that the crisis-induced reforms of the international regulatory framework impose tighter capital, liquidity and leverage requirements on banks with the objective of building a safer financial sector and with long- BIS central bankers’ speeches term effects on their lending capacity. Overall, banks will become more selective in their credit decisions and will adjust their business models accordingly. The European Commission proposal unveiled last February to establish a Capital Markets Union (CMU) by 2019 has among its primary objectives the lowering of barriers to accessing equity and bond markets. Obstacles are particularly severe in the case of small- and medium-sized enterprises aiming at raising risk capital. This objective implies that particular attention should be given to the complementarities between bank financing and market financing, rather than considering the two as obvious alternatives. And such complementarities are indeed numerous, both at a macro and a micro level. At a macro level, the CMU must be seen as a natural complement to the Banking Union in providing macro-financial stability. At the risk of oversimplifying, we may say that the latter addresses the sovereign-bank negative feedback loop that epitomized the euro area crisis while the CMU contributes to tackling another potential circle that can be at least equally vicious: the firm- bank loop, whereby the funding difficulties of banks – or, even worse, pressures to deleverage – translate into more costly or less financing for creditworthy firms; in the reverse situation, when firms face problems in servicing bank credit, non-performing loans increase, weakening banks’ balance sheets and impairing their lending capacity. At a micro level, the CMU can complement the banking sector in fostering innovation while also strengthening firms’ financial structures. Research has long documented the fact that, among external sources, equity financing is best suited to foster innovative activities, for a number of familiar reasons. Start-up firms display stronger information asymmetries and have typically low or even no tangible assets to offer as collateral for bank loans; furthermore, private equity or venture capital financiers foster innovation not only by providing capital but also managerial expertise and deeper knowledge of innovative sectors. There is evidence that equity financing spurs innovation also for Italian firms. The benefits of broader capital markets also extend to those which in principle can be seen as competitors, i.e. banks. High quality securitization, one of the CMU’s short-term priorities, can free up banks’ regulatory capital and increase their lending while allowing them to manage credit risks more efficiently. And broadening financing sources for SMEs can be beneficial not only for these firms but also for banks. By facilitating firms’ access to non-bank financing, notably equity capital, and improving their financial structure, CMU helps make firms more creditworthy, thus safeguarding banks’ balance sheets. Besides, banks can increase fee-based revenues by providing consulting services to firms that want to access capital markets. The CMU project is ambitious and prioritization is the key to advancing it effectively. In the short term, priorities should include: the simplification of the prospectus Directive, so as to facilitate listing for firms, especially SMEs; the standardization of information on credit quality; the development of a market for simple and transparent securitizations, possibly subject to favourable prudential treatment; the promotion of cross-border investments in venture capital; and the creation of a European private placement market, a form of financing that allows firms to place their bonds with one or more institutional investors at a lower cost than that of issuing securities to the public. Challenges are stronger over the longer term, as a full CMU requires harder tasks such as harmonization of the various countries’ company and bankruptcy legislation as well as reduction in the differences between the tax treatment of capital gains. Legislative harmonization will inevitably be a gradual process; a modular approach seems the most reasonable course of action to follow, starting with the easiest reforms and then gauging where there is room to tackle more ambitious challenges. I have recently highlighted the distinctive importance of the CMU project for Italy. The country is a case in point as to the risks of relying excessively on a single source of financing, namely bank credit. Several years of financial crisis, a major effort to restore fiscal sustainability and two recessions have severely impacted on the Italian economy and its banking system. In BIS central bankers’ speeches turn, banks’ difficulties hit Italian firms strongly as they are generally more dependent on bank credit and less capitalized than their European counterparts. By favouring access to non-bank financing, CMU can complement legislative measures adopted over the last few years that are underpinning progress towards a stronger financial structure for Italian firms. The introduction in 2011 of an Allowance for Corporate Equity and its further extensions have almost completely eliminated the previous fiscal incentive for debt; this should stimulate firms’ raising of equity capital. Also, new stock market listings have increased, the volume of bond issues has gone up, including for medium-sized firms, and the number of mini- bond issuers has been rising. Obviously a key goal of the CMU is to support and complement the Investment Plan for Europe. Business investment remains sluggish and weaker external and domestic demand is hampering a stronger recovery. Conclusions Due to the incompleteness of the European construction, the recent crises dramatically exposed the reversibility of even the major progress towards European financial integration made since the introduction of the euro. Even worse, at one point the sovereign debt crisis threatened the very survival of the euro project itself. As part of the multi-faceted European strategy to respond to the crisis, the establishment of the Banking Union and the launch of the Capital Markets Union proposal are complementary milestones and are part of the efforts we are all engaged in towards completing the Economic and Monetary Union and making it stronger. The establishment of the Single Supervisory Mechanism has been an important step towards overcoming the euro area sovereign debt crisis and a key driver in underpinning a major strengthening of banks’ balance sheets. This has paved the way for improving their capacity to finance the euro area economy. In the medium term, however, banks’ capital strengthening has to stem from economic recovery. Efforts are therefore needed at all levels – both national and European – to promote growth. The Single Resolution Mechanism and the Bank Recovery and Resolution Directive are ushering in a new framework for managing bank crises; equally important, they can play a role in crisis prevention by promoting market discipline. By broadening non-bank sources of financing for firms and households, the Capital Markets Union will further advance European financial integration while fostering economic growth and financial stability. BIS central bankers’ speeches | bank of italy | 2,015 | 9 |
Speech by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy, at the "Roundtable on Monetary Policy in a Low Growth, Low Interest Rate Environment", Istanbul Finance Summit, Istanbul, 8 September 2015. | Salvatore Rossi: Monetary policy in a low growth, low interest rate environment Speech by Mr Salvatore Rossi, Senior Deputy Governor of the Bank of Italy, at the “Roundtable on Monetary Policy in a Low Growth, Low Interest Rate Environment”, Istanbul Finance Summit, Istanbul, 8 September 2015. * * * The role of interest rates – short- or long-term, nominal or real – is pervasive in modern economies. Changes in interest rates affect: the value of wealth accumulated by savers, their propensity to save, the financing cost for borrowers, the evaluation of investment projects, the sustainability of fiscal debt, the stance of monetary policy. And the list could go on. We know that in many advanced economies, short- and long-term nominal interest rates are at historically low levels. And they have been very low for several years by now. This environment should not be viewed merely as a consequence of the central banks’ reaction to the global financial crisis; in a longer time perspective, it is also the end point of a trend. Some data: since the early 1990s the 10-year nominal yields on Government bonds have declined by 10 percentage points in the UK, 9 in the euro area, 6 in the US and Japan; short-term nominal interest rates have followed a similar pattern though with a larger volatility. How come? What are the associated risks and policy changes? In trying to answer these questions let me first recall that the nominal interest rate can be viewed as the sum of three components: 1) the real interest rate, 2) the expected inflation, and 3) a term premium. Economic theory tells us that the real interest rate is the price that equates the supply of savings with the demand for funds aimed at financing investment. Supply and demand, in turn, are determined by factors such the preference of households to smooth consumption across time and the productivity of capital. The expected inflation and the term premium components of the nominal interest rate are self-explaining: when buying a long term bond I want a return that could compensate me for the potential loss in my future purchasing power, and for the risk of a potential capital loss if I needed to sell the bond prior to maturity. A lot of influencing factors are involved here: expectations about future economic growth and inflation; the degree of risk aversion; financial markets volatility, domestically and abroad, since capital markets have become globally integrated. Which of these factors can explain the current low interest rate environment? I would indicate two sets of factors: transitory, and structural. The latter are particularly important, since they may suggest that the current environment is a long-run phenomenon, bound to stay with us for quite some time. The transitory factors are evident: first of all the expansionary monetary policy stance put in place by many central banks in response to the global financial crisis, and, in the euro area, also to the sovereign debt crisis. We know that most central banks in the advanced countries, as policy rates were reaching the zero lower bound, have enriched their monetary policy toolbox with various unconventional measures, the most important and visible one being programs of securities purchases (QE). Another transitory factor is the de-leveraging by the private sector. In part this is due to a financial regulation becoming much stricter than before the crisis. BIS central bankers’ speeches And here comes the structural factors. They can be summarized as follows: an excess of desired saving over desired investment, leading to lower economic growth and real interest rates. This is essentially the secular stagnation hypothesis proposed last year by Larry Summers. 1 Barry Eichengreen, one of the most prominent economic historians of our times, has recently written an illuminating article on this topic. 2. He discusses four possible explanations. 1) High savings rates in emerging-market economies. This is the well-known global savings glut hypothesis put forward years ago by Ben Bernanke. 3. The idea is that in some emerging countries, China in particular, social protection systems are so limited and weak that households feel forced to increase their precautionary saving. 2) The decline in the relative price of investment goods (machinery, equipment, ICTs), thanks to technological progress. For a given investment project, a fall in the relative price of investment reduces the demand for funds. With less investment spending chasing the same savings, the result can be a lower real interest rates and, potentially, a chronic excess of desired saving over desired investment. 3) A lower rate of population growth, in the advanced economies and now also in some emerging markets. It is reflected in a slower growth of the labor force, in turn requiring less investment. 4) The fourth possible explanation is the more controversial one. The idea is that the pace of scientific and technological inventions has slowed down, since the golden XX century of electricity and ICTs, and will never recover, causing a corresponding permanent scarcity of high-return investment opportunities. Robert Gordon is a supporter of such a pessimistic view. 4 Personally, I don’t believe in this fourth factor: the innovative capabilities of humankind have always caught philosophers and economists by surprise. But the other three factors are serious and deserve to be addressed. Let me now briefly touch upon some policy implications. Nearly eight years after the onset of the financial crisis, global growth is disappointing on average, but with a high variance across countries and regions. The U.S. recovery is continuing at a sustained pace, while growth in the euro area and Japan is currently still modest, though expected to pick up. Emerging economies’ growth will decline for the fifth year in a row in 2015, although these economies will continue to increase their share of global GDP. Against this outlook, monetary policy stance across major economies may become asynchronous in the coming months, when the Federal Reserve will actually start the announced normalization process. The big question is: how much transitory are the transitory factors explaining the current low interest rate environment? What will happen when monetary policy normalizes? Or will the structural factors prevail and keep real and nominal interest rates low forever, or at least for a very long time? Summers, H. L. (2014), “U.S. Economic Prospects: Secular Stagnation, Hysteresis, and the Zero Lower Bound.” Business Economics, 49, pp. 65–73. Eichengreen, B. (2015), “Secular Stagnation: The Long View.” American Economic Review, pp. 66–70. Bernanke, B. S. (2005), “The Global Saving Glut and the U.S. Current Account Deficit.” The Sandburg Lecture, Virginia Association of Economists, Richmond, VA, March 10. Gordon, R. (2012), “Is U.S. Economic Growth Over? Faltering Innovation Confronts the Six Headwinds.” National Bureau of Economic Research, Working Paper 18315. BIS central bankers’ speeches On the first point, Reinhart and Rogoff, 5 among others, have shown that in the aftermath of financial crises economic recessions tend to be more severe than in typical business cycle recessions and the recovery takes longer. Credit cycles last longer than business cycles. But eventually they come to an end, once households’ and corporates’ balance sheets have been repaired. And that poses the problem of how and when normalizing monetary policy. On the second point, a challenge relates to possible spillover effects on emerging-market economies of changes in the monetary policy stance in advanced countries. Large capital flows went to emerging-market economies in the last years, in search for yield, putting upward pressure on asset prices and exchange rates in those economies. They might suddenly reverse when monetary conditions change in advanced economies. The risk is that the process becomes disorderly, with impaired liquidity in certain markets or asset classes, rapidly diffusing contagion to other correlated asset classes. These risks call for clear and effective communication strategies by central banks, while the authorities in emerging economies should further strengthen policy buffers and further advance structural reforms. Another delicate policy challenge regards the relation between monetary and fiscal policies. The combination of high public debt – accumulated in many advanced economies in response to the financial crisis – and very low interest rates has strengthened the interdependencies between the two policies. Exceptionally low nominal interest rates have contained debt servicing costs, and that’s good news; the flip side is that fiscal positions are highly exposed to changes in the monetary policy stance, especially if changes are abrupt. Finally, what if the current low interest rates were the new long-run equilibrium? In this case I would see serious challenges for monetary policy management. Central banks might more often encounter the zero lower bound on nominal rates, which would imply less room to maneuver the policy rate to counteract deflationary shocks. The economy would be less resilient to negative shocks. Central banks might have to increasingly resort to what we call unconventional policies. But we do not know how effective these tools are as a normal business cycle stabilizer, and what macroeconomic risks they might entail. Let me conclude signaling another risk. Economic policies became exceptionally accommodative after the financial crisis in order to save the world from another Great Depression. Financial panic was destroying households’ and corporates’ confidence and curtailing aggregate demand, so macroeconomic policies, both fiscal and monetary, had to fill the gap, as long as needed. The phase of very low nominal interest rates has been necessary, and still is necessary in many areas of the world including the euro area, in order to support growth, fight deflation risks and sustain employment. But low growth, and the ensuing low interest rates, risk feeding on themselves if allowed to linger for too long: households may eventually feel compelled to save more, because they see, for instance, their insurance policies and retirement schemes at risk of not being fully honored. At the same time, low growth implies low return from real investment, and this creates perverse incentives to search for yield taking risk on board; this may jeopardize financial stability. One main lesson comes from these considerations. The most effective and long-lasting solution to tackle the declining trend of real interest rates is to act forcefully and preemptively to support growth. Support remains necessary from the demand side; but in the longer run it must come from the supply side, by identifying and implementing those reforms that, encouraging investment, may boost productivity and support job creation. We need to prove Robert Gordon’s prophecy wrong. The consequent increase in potential economic growth would raise the real interest rate and push nominal interest rates into a safer territory. Reinhart, C. M. and Rogoff, K. S. (2009), “This Time Is Different: Eight Centuries of Financial Folly.” Princeton, New Jersey: Princeton University Press. BIS central bankers’ speeches | bank of italy | 2,015 | 9 |
Statement by Mr Ignazio Visco, Governor of the Bank of Italy and Governor of the Constituency of Albania, Greece, Italy, Malta, Portugal, San Marino and Timor-Leste, to the Development Committee, Lima, 11 October 2015. | Ignazio Visco: New global challenges and the global economy Statement by Mr Ignazio Visco, Governor of the Bank of Italy and Governor of the Constituency of Albania, Greece, Italy, Malta, Portugal, San Marino and Timor-Leste, to the Development Committee, Lima, 11 October 2015. * 1. * * Adjusting to new global challenges The recent approval of the Sustainable Development Goals comes at a challenging moment for the global economy. The important development successes since 2000 should not make us complacent. Poverty has fallen substantially, but it is deep and concentrated. Furthermore, growth is losing steam in some developing economies while in others economic activity is heavily affected by the downturn in commodity prices. More importantly, growth alone will not be sufficient to reach the deepest pockets of poverty and boost shared prosperity. We welcome the emphasis of the Global Monitoring Report (GMR) on the non-income dimensions of development, which do not always correlate well with poverty measured by the money metric. A proper analysis of these dimensions is essential for eradicating poverty and increasing shared prosperity in a comprehensive way. The GMR also rightly points to demographics as a crucial factor in shaping the evolution of the global economy in the next fifteen years. Key drivers of population dynamics are migration flows. Cooperative policies regulating migration between countries affected by demographic decline and those experiencing high population growth could ease regional aging pressures and smooth trends in population growth. In this context, the upheaval caused by conflict outbreaks has intensified the already strong trend to migrate and resettle brought on by often dramatic economic conditions and global and domestic shocks. Dealing with the root causes of migration requires development policies that grant poor countries better market access for their products and transfer expertise and technological know-how to speed up development. On its own, however, foreign aid may not be sufficient. For it to be effective, it also requires coherent development programs. Large flows of foreign aid, for example, are unlikely to be helpful if they finance unproductive investments or delay needed structural reforms. On the contrary, when foreign aid complements domestic policy reforms in the recipient country it can ease the costs of adjustment, provide a catalyst for change, and thereby drive a sustainable improvement in the country’s growth prospects. 2. Providing voice and vision to the new global economy In the context of the Bank’s periodical shareholding reviews we recommit to reaching an agreement on a realignment mechanism based on a formula. This will ease the task of maintaining an equitable representation of shareholders over time and will strengthen the IBRD legitimacy as a global player. The formula should reflect global economic weights and the contributions to the Bank’s development mission. Rewarding support to this mission is essential to building up adequate incentives for future contributions. Any discussion of future resource needs to be preceded by a thorough conversation on the future positioning of the Bretton Woods institutions. A long-term vision of the role of multilateral financial institutions – and of the WBG in particular – needs to take into account the importance of engaging in the financing of global public goods and the benefits of cross-border integration. This requires the promotion of regional cooperation efforts. We should at the same time recognize that official development assistance represents only a small portion of global financial flows for development. The role of the WBG in enhancing the use of domestic resources – through technical assistance – should be intensified, and IFC and MIGA should BIS central bankers’ speeches strengthen their efforts to catalyze private sector capital into development projects. The time is ripe for updating the IDA financing model. 3. A partner in climate change financing As we approach the COP21 meeting in Paris, where decisions need to be taken to step up international action on climate change, we envision an important role of the WBG as a key partner in both promoting the transition to a “greener” economy and alleviating the impact of climate change on developing countries. This effort requires financial resources that largely exceed those available to development institutions and calls for combining limited public resources with larger private sources of capital. The WBG is strategically positioned to contribute to this effort. The problem of climate change falls in the domain of global public goods and posits complex intergenerational questions. As a global financial organization, the World Bank is well-suited to address both these issues. Furthermore, as a multi sector development agency, the Bank should make use of its expertise in a broad array of policy areas to provide sound evidence that climate-smart projects are good development projects. 4. A sustainable development organization We welcome the substantial increase in WBG commitments. It is now time to deliver with an effective implementation of WBG projects. Large, transformative development solutions require a focus on results and appropriate fiduciary and safeguards policies to manage risks. The IBRD should focus on financing long-term structural projects, even if the shift toward investment lending is likely to reduce the growth of the IBRD loan portfolio. This requires a set of strategic priorities fully shared by the institution at all levels and supported by robust analytical evidence. A balanced structure of revenues and expenses will effectively protect capital from the vagaries of the economic cycle. The prolonged period of low interest rates continues to constrain the income of the IBRD and calls for a continuous monitoring of efficiency-enhancing measures. The objective of the full implementation of the new organizational structure should be efficiency. Efficiency must remain a guiding principle once financial sustainability is eventually achieved. All these challenges call for strategic prioritization and joint action. Over the decades, the World Bank Group has consistently displayed a remarkable capacity to adapt to the changing external environment, redefining its mission over time and expanding its clientele and its tools. At this critical juncture we have no reason to doubt that it will once more rise to the level of the challenge. BIS central bankers’ speeches | bank of italy | 2,015 | 10 |
Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the 91st World Savings Day, organised by the Association of Italian Savings Banks (ACRI), Rome, 28 October 2015. | Ignazio Visco: 2015 World Savings Day Address by Mr Ignazio Visco, Governor of the Bank of Italy, at the 91st World Savings Day, organised by the Association of Italian Savings Banks (ACRI), Rome, 28 October 2015. * * * Since the beginning of this year the cyclical improvement has spread throughout the euro area, benefiting from the expansive measures adopted by the ECB Governing Council. The cyclical indicators confirm the continuation of the upswing in the third quarter in the area as a whole and in Italy, with growth rates similar to those of the two previous quarters. Italian GDP has returned to growth for the first time since the inception of the sovereign debt crisis, at annualized rates of around 1.5 per cent. The initial stimulus from foreign demand has been flanked by a boost from domestic demand components with the consolidation of the recovery in private consumption and a gradual revival in investment. Business surveys confirm growing optimism about demand, favouring the propensity to invest. The significant expansion of employment, which has also benefited from government measures, will continue to sustain household consumption. In 2015 economic activity could grow by close to 1 per cent, faster than our July forecast indicated. Looking ahead, however, the euro area and Italy face risks in connection with the Chinese economic slowdown and, more broadly, developments in the emerging economies. The repercussions on world trade and commodity prices are delaying the return of inflation to levels nearing 2 per cent. The Governing Council of the ECB is determined to use all the instruments available within its mandate in order to achieve the most appropriate degree of monetary accommodation under the current circumstances. We will assess the need for additional monetary stimulus at our meeting in early December. 1. Credit access and cost Credit dynamics have improved in the course of the year, benefiting from the economic recovery and the plentiful liquidity made available by monetary policy measures. The volume of lending to households has increased, albeit slightly, compared with the previous year. Credit to manufacturing firms was up by 1.8 per cent in September, and the contraction of lending to service firms moderated significantly; for construction firms, which are still penalized by an uncertain outlook for the housing sector, the attenuation was less pronounced. The monetary policy measures had an even greater impact on the cost of credit. The average interest rates on credit to firms and loans to households for house purchase in the euro area dropped to their lowest levels since 2003 (when the collection of harmonized data began); in August they were at 1.8 per cent and 2.3 per cent respectively. Differences between countries, which had increased greatly in 2011–2013, narrowed considerably. The average interest rate spread between Italy and the euro area for new floating-rate mortgage loans and new financing to firms dropped to around 10 basis points. In Italy, the heterogeneity in lending terms and conditions for firms according to size and risk profile is also gradually diminishing, following a sharp increase during the recession. Since the middle of 2014 the decrease in banks’ lending rates, which had initially only benefited the largest and financially soundest firms, has gradually spread to the rest. The reduced dispersion of interest rates is related to the improvement in the macroeconomic picture, which has been reflected in a generalized improvement in the outlook for earnings. This is confirmed by business surveys: the share of firms that expect to post a profit for the year is the highest in a decade. Interest rate dispersion is still historically high, but there is scope for a further decrease as the recovery firms up and the quality of credit consequently improves. BIS central bankers’ speeches The harmonized interest rates on new loans to firms and households are the best gauge of the effectiveness of monetary policy, as they react most quickly to changes in monetary conditions. However, their information content as regards the terms and conditions of lending to single borrowers is only partial, because the harmonized rates are calculated as weighted averages based on loan amounts, exclude non-performing loans and, for almost all types of financing, are net of fees and other charges. Further information on the lending conditions for different categories of Italian borrowers may be drawn from other data collected and published by the Bank of Italy, and in particular the data supplied to the Ministry of Economy and Finance for the purposes of the anti-usury law. These rates are calculated as simple averages, and they include non-performing loans (but not bad debts) and bank fees. They may therefore be higher, and in some cases considerably higher, than those calculated by the harmonized method. The impact of bank fees is greatest on current account overdrafts, which are commonly used in Italy, particularly by small firms, which also rely on this instrument for liquidity management services, which are remunerated by the fees. As the fees are, at least partially, fixed, they have a larger impact on small loans. The widespread use of overdrafts in Italy, much greater than in almost all the other euro-area countries, should prompt a rethinking of their utilization. Firms need to consider more efficient and less costly methods for managing liquidity; they should also weigh the advisability of greater resort to fixed-term loans. Banks must guarantee that the liquidity management services embodied in current account overdrafts do not cost more than their effective value, and they must also take account, in their pricing, of the indirect advantages they reap from the provision of these services. In fact, when the counterparties are small firms, the information asymmetry between banks and firms is more severe, and managing the firms’ liquidity enables banks to gather further information, thereby attenuating the risks connected with difficulties and uncertainty over the timing of credit recovery procedures. In August the Bank of Italy opened consultation on a draft of the resolution to be submitted to the Credit Committee on the implementation of the newly revised Article 120 of the Consolidated Law on Banking, which governs accrual of compound interest on banking transactions. Our proposal – prepared as required by the law – is intended as a clarification in the interests of transparency of the rules. It is based on a reading of the law that is shared by the Ministry of Economy and Finance. The solutions set out implement the principle established by the law, namely the ban on compound interest on banking transactions, in keeping with the economic substance of contractual relationships and avoiding uncertainty and any effect on debtors that is contrary to the intentions of the legislature. The most technically complex case to regulate is the current account overdraft, which, as I just now noted, is a much more common form of credit in Italy than elsewhere. Since the law states that banks cannot require the automatic settlement of the interest due on overdrafts, we have had to create a framework of legal certainty to cover situations in which the customer lacks – even temporarily – the liquidity needed to pay the interest on the due date. The proposal settles this issue by forbidding banks from taking immediate action. It allows the payment of interest by debiting the account, after a period of 60 days has elapsed, only at the request of the customer, who has an interest in allowing payment in order to avoid the legal and practical consequences of non-performance that he could otherwise suffer, including default penalties and revocation of the credit line where the requisite conditions apply. Finally, in accordance with the law’s purpose, the draft proposes that interest be calculated only once a year and not quarterly, as is the usual practice. The consultation document envisages that the resolution be applied only after it enters into force, in accordance with general legal principles. It does not take a position on how the law should be applied prior to action by the Credit Committee. We hope for clear guidance on BIS central bankers’ speeches this delicate issue, which will continue to be evaluated in light of the case law, in order to ensure certainty in the law and in banking transactions. The consultation was concluded a few days ago. We received numerous comments from an ample cross-section of participants. We will analyse them carefully and consider the suggestions for improving the text to be submitted to the Credit Committee. 2. Savings and the management of banking crises Starting next year the new European banking crisis resolution system will be fully operational with the transposition of the EU Bank Recovery and Resolution Directive (BRRD). The system forms part of the broader process of reforming international financial rules to reduce the probability and the impact of bank failures by strengthening capital requirements, setting limits on financial leverage and instituting new minimum liquidity ratios. Banks deemed to be systemically important are subject to additional safeguards, and further measures are being discussed at the international level. It must be understood that the new rules will tend to diminish both the profitability and the size of banking systems, shifting a portion of the financing of the real economy to the capital market and increasing the relative importance within the credit market of institutional investors other than banks. In Italy, a shift of this kind in the financial system has long been desirable to accompany the transition of the economy towards a more modern structure, with less bank debt and more equity and bond issues. Under the new European system the Single Resolution Board and the national resolution authorities will be responsible for handling bank crises, with a division of competences that takes account of the type of intermediary involved and the possible need for recourse to the Single Resolution Fund. The Bank of Italy, designated as the national resolution authority, has created a special unit that reports directly to the Governing Board and is independent of the Directorate General for Financial Supervision and Regulation, as required by European legislation. The European regulatory framework envisages a variety of tools to help failing banks restructure or exit from the market without interrupting the provision of critical functions and jeopardizing the overall stability of the financial system. The primary innovation is the bail-in procedure, which requires shareholders and creditors to directly bear the losses incurred by banks in difficulty and to shoulder the burden of recapitalizing them. This tool, which is entirely new for Italy, was requested specifically by those EU countries that had to intervene heavily to support their banking systems during the recent global crisis. In the euro area, these measures weighed on the public debt to the tune of around 5 percentage points of GDP in Belgium, the Netherlands and Spain, more than 8 points in Austria and Germany, over 10 points in Portugal and over 20 points in Greece and Ireland. In Italy, although the economy was hit harder by the recession than most of these other countries, the system required practically no public intervention. Now, notwithstanding the undeniable success of our model of banking supervision and crisis management in containing and resolving cases of failure, with extremely marginal use of public resources, this model must be adjusted to bring it into line with the new European rules. In applying the bail-in procedure, we must take into account the need to protect creditors while at the same time safeguarding financial stability. We must act to make sure the procedure is applied only in limited and extreme circumstances. The priority ranking of creditors will, in any event, be respected, and no creditor will have to bear losses greater than those that they would suffer if the failing bank were liquidated under ordinary bankruptcy procedures (“no creditor worse-off” principle). BIS central bankers’ speeches Bail-ins will not affect deposits up to €100,000, which in no case will be called upon to contribute to the costs of resolution. Deposits above this threshold, going by the current wording of the legislation transposing the Directive, will get preferential treatment over other liabilities of the bank; consequently there is little chance that they will be hit by the resolution of a crisis. Unsecured bank bonds may be subject to the bail-in tool, after regulatory capital instruments and subordinated debt. It is essential, therefore, that banks, bearing this risk in mind, fully discharge their obligations of transparency and correctness in the issuance, placement and trading of these securities with retail clients. The authorities will monitor compliance with the rules. Banks, for their part, will have to consider how to direct less sophisticated customers towards more secure forms of funding, those better protected in case of crisis. To avoid the possible adverse effects of bail-ins, the resolution authorities will make sure that banks carry the right amount and type of liabilities to ensure the absorption of losses and recapitalisation; they may require that a part of the minimum requirement for liabilities eligible for the bail-in tool consists of subordinated debt. In a resolution, where necessary to safeguard systemic stability and the continuity of essential business functions, the resolution authorities may exclude additional liabilities and resort instead to the resolution fund once at least 8 per cent of the liabilities of the bank in crisis have been bailed-in. In recent years we have managed a number of crisis situations, without losses for depositors, costs to the Treasury, market distortions or interruption of essential services provided by the banks. These objectives continue to guide the actions of the Bank of Italy, in a context that is complicated by the transition towards the new resolution system and the increased importance of the intermediaries involved. Recourse to certain instruments widely used in the past, such as the support provided by deposit guarantee funds, has been called into question by the recent European Commission stance on state aid; this field is often marked by uncertainties, which may hinder the rapid action indispensable in crisis management. The European authorities would do well to favour coordination and certainty of law in the application of the competition provisions and the rules on bank resolution. 3. The state of Italian banks 3.1 Non-performing loans Italian banks’ large stock of non-performing loans is a legacy of the long and deep recession. Their rapid reabsorption would facilitate a recovery in lending and a lowering of the cost of credit. Parliament’s recent measures to shorten credit recovery times are a step in the right direction and are helping to rekindle interest in investing in the non-performing assets of Italian banks. It is estimated that if Italian recovery time had been as short as those of France and Germany, the ratio of bad loans to total loans would be less than half what it is now. What matters now is to implement the measures rapidly. The efficacy of the bankruptcy procedures could be further enhanced by strengthening the organizational and independence requirements for curators and special administrators; significant impetus could come from the institution, as in other jurisdictions, of a publicly accessible national electronic register containing all the information and relevant documents relating to foreclosure and bankruptcy proceedings. In the three years 2012–14, Italian banks sold or securitized bad loans amounting to about €11 billion (around 2 per cent of their outstanding bad debt). In the early months of this year, the sales continued to be for small amounts. For the most part the transactions involved the major groups and foreign banks operating in Italy. The smallness of the transactions to date can be ascribed to information asymmetry between buyers and sellers relating to poor data management at many banks and the objective difficulty of assessing the conditions of many indebted small businesses. Public intervention, obviously in compliance with the regulations BIS central bankers’ speeches on state aid, could facilitate the development of this market, serving as a catalyst for private sector initiatives. While the discussion continues on this matter between the Italian government, assisted by the Bank of Italy, and the European Commission, further studies are being conducted to ascertain the actual interest of both potential investors and banks in a company to purchase and manage impaired assets, operating at market conditions. Public participation in this asset management company would be marginal or nil; there could be a state guarantee for the senior liabilities it issues to finance its asset purchases. Over the next few weeks the feasibility of the project will be definitively determined. Regardless of the outcome of the verification, banks burdened by large non-performing exposures will still have to identify, in accord with the supervisory authorities, the best procedure for efficiently managing those assets in order to gradually work off the overhang. 3.2 Governance, cooperative (popolari) banks and mutual banks Change to the banking system has been given significant impetus by the reform of Italy’s main cooperative (popolari) banks. The first steps provided for by the law for their conversion into joint stock companies have been taken: the presentation of the plans laying out the steps required and the timeframe within which the operations will be completed, which in many cases could be by the middle of next year. In recent days the project for the conversion of one large cooperative group – directly subject to the Single Supervisory Mechanism – was approved by the shareholders’ meeting. As I have often had occasion to observe, a change in the legal form provides a golden opportunity for strengthening corporate governance to permit more rapid access to capital markets and facilitate mergers that could help to increase profitability. It is not for the authorities to suggest or impose any merger plans, which must be identified and decided by the corporate bodies themselves. Merger projects developed by the market will be carefully appraised in terms of their current and future financial soundness and the effects on the banks’ situation. For some unlisted cooperative banks, conversion into joint stock companies will be part of a broader transformation of governance also comprising stock exchange listing. These interventions will greatly enhance access to capital markets and help overcome the problems with the current process of share price determination, which the law reserves to the shareholders’ meeting. Stock exchange listing will also ensure the liquidity of the investments of shareholders who wish to dispose of their holdings. The Banca Popolare di Vicenza is one of the cooperative banks that have embarked on this process as part of the measures required by the supervisory authorities. As the explanatory note published on our website yesterday describes in more detail, in 2014 evidence emerged that this bank had committed irregularities in share buybacks. In agreement with the new European supervisory bodies, which were about to start operating, we scheduled a targeted inspection for immediately after the European Comprehensive Assessment. This intervention, conducted by Bank of Italy inspectors as part of the Single Supervisory Mechanism, revealed other practices not in compliance with the rules. As soon as the initial findings of the investigations begun last February started to emerge, the Bank of Italy and the ECB concurred fully on urging the Banca Popolare di Vicenza to adopt immediate corrective measures. The top executives and almost all of the senior management were replaced; a capital strengthening plan was drawn up, the success of which is ensured by the presence of an underwriting consortium; and a radical reform of corporate governance is planned for the cooperative’s conversion into a joint stock company and its simultaneous stock exchange listing. A reform of the mutual banking sector is also needed now. Self-financing, the main source of funds for increasing these banks’ capital, has essentially dried up as a result of the recession. In the absence of any decisions, the necessary increase in provisions to cover BIS central bankers’ speeches non-performing loans would lead to a further reduction in the capacity for self-financing; a significant part of the mutual banking system would incur negative evaluations by the supervisory authorities and might not be able to meet the need for a larger capital endowment. This could give rise to situations that would be difficult to manage within the new crisis resolution framework, also considering the constraints of the regulations on state aid. Mutual banking systems in other euro-area countries have long since instituted highly integrated organizational structures capable of realizing economies of scale, unitary risk control mechanisms, and safety nets for the liquidity and solvency of the participating banks. Some of these arrangements are already in place among Europe’s major banking groups. We have followed the recent discussion within the mutual banking sector over plans for selfreform. A point on which there is still open debate is whether there should be just a single mutual banking group or more than one. The idea of a single group, if agreed upon within the category, certainly has positive aspects, but the possible lack of consensus on a single group should not be a reason for blocking the reform. Greater capitalization, greater efficiency and improved corporate governance could also be achieved by a limited number of groups. * * * If economic activity falters and incomes shrink, as has happened in Italy for seven long years, it then becomes difficult to protect savings. The first response is macroeconomic policies and decisive and forward-looking structural reforms to promote strong and balanced growth, efforts to which we are strongly committed as part of our mandate as the central bank. A long and deep recession weighs heavily on the banking system. Recent years have also seen serious instances of malfeasance, compounded by the economic problems in themselves. We are active in countering situations of serious difficulty or crisis by means of supervision, strict enforcement of the rules, and verification of organizational adequacy, prudence in lending, and transparency and correctness in funding. When a crisis does occur, action must be taken to resolve it and limit its repercussions. This is no easy task, it is a constant challenge, yet those episodes of malfeasance that have occurred in these difficult years came to light also thanks to the usually decisive if not always publicly known contribution of the Bank of Italy. Notwithstanding the recession and notwithstanding instances of misconduct, the system as a whole has held firm. I am confident that the banks, good credit and sound finance, will contribute significantly to the economic recovery, which needs to be consolidated and strengthened. Our economy must make up for its accumulated lag in adapting to the transformations of the global economy, technology and demographics, a process in which finance and the banks will play a vital role. BIS central bankers’ speeches | bank of italy | 2,015 | 11 |
Lecture by Mr Ignazio Visco, Governor of the Bank of Italy, at the London School of Economics Institute of Global Affairs and London School of Economics Student's Union Italian Society, London, 11 November 2015. | Ignazio Visco: “For the times they are a-changin’…” Lecture by Mr Ignazio Visco, Governor of the Bank of Italy, at the London School of Economics Institute of Global Affairs and London School of Economics Student’s Union Italian Society, London, 11 November 2015. * * * This text draws on the first chapter of Perché i tempi stanno cambiando, Bologna, Il Mulino, 2015, which originated from the author’s “Il Mulino Lecture”, 18 October 2014. I wish to thank Andrea Brandolini, Salvatore Rossi and Francesco Spadafora for their many useful comments. “For the times they are a-changin’”. This is what Bob Dylan famously sang over fifty years ago. And in this half-century, the times truly have changed. The history of humankind is in itself a story of change: demographic, technological, religious, social, political, economic. Economists often distinguish between “growth” and “development”. The former refers to the production of goods and services exchanged in markets, which is an ingredient, and an important one, in economic and social well-being. It needs to be considered, however, together with the other components of a society’s development, such as the distribution of natural resources, health and living conditions, or the quality of the environment. All these elements are often but imperfectly correlated with measures of economic activity like the gross domestic product, itself a useful but limited indicator whose utilisation as an exclusive gauge has at times come under comprehensible criticism. In this regard, let us start with two issues. The first concerns labour, work. As Voltaire’s Turk explains to Candide, work serves to ward off not just need, but also boredom and vice. If our living conditions have improved so enormously over the past few centuries, we owe it largely to one fundamental institution, the market, which made it possible to transcend the old subsistence economy based on barter. In the long run, market failures – which may range from monopolies and positional rents to laws and customs unfavourable to business activity or rules and supervisory practices incapable of deterring excessive risk-taking – engender disequilibria, impede growth, undercut labour and hinder development. The second question bears on the models used by economists. Often, these models depict economic growth as a balanced, linear process, but in reality it is far from regular, a fact that does not escape economists themselves. Yet over the past two centuries the market, demographics and technical progress have produced wealth, work, and better living standards for steadily increasing masses of people. This has come about through a series of social, individual and collective travails that have made the process non-linear, yet not random. In what follows I will discuss the theme of change, in particular the rapid and constant change now associated with technological developments, and the multiple interactions between the legacy of the global financial crisis and new challenges. An increasingly important issue in the debate is the impact of new technologies on jobs and on the skills required to seize the opportunities and govern the risks of the digital revolution. From industrial revolution to sustainable development The industrial revolution of the late eighteenth century gave rise to the “first machine age” (the second is the age we are now living in, as described by Erik Brynjolfsson and Andrew McAfee). 1 Innovation and automation have gradually transformed material production, in E. Brynjolfsson and A. McAfee, The Second Machine Age: Work, Progress, and Prosperity in a Time of Brilliant Technologies, New York, W.W. Norton & Company, 2014. BIS central bankers’ speeches agriculture and industry alike, and especially in manufacturing. The new opportunities created over the course of this extraordinary period of human history have more than offset the jobs destroyed by the new general purpose technologies: the steam engine, the internal combustion engine, electric power. In Why the West Rules – for Now, 2 the Anglo-American historian Ian Morris develops an index of social development based on energy use, civil organisation, military capability and information technology. Brynjolfsson and McAfee observe that his index points to an astonishing conclusion: none of the crucial innovations antedating the industrial revolution – the domestication of livestock, the development of agriculture, the foundation of cities, the rise of philosophy and the great religions, the invention of writing, the introduction of numbers – had anything like the importance for socio-economic development of the exceptional discontinuity of the late eighteenth century. This break was accompanied by the growth of world population from 800 million in 1750 to over 1.5 billion in 1900, 2.5 billion in 1950, 3 billion fifty years ago and over 7 billion today. It was precisely the postwar exponential demographic acceleration – the “population explosion” – that prompted discussion on the “limits to growth.” At the start of the 1970s the Report of the “Club of Rome,” 3 which centred on the predicted depletion of natural resources, raised alarm about the survival of the Earth’s ecosystem and of the human species itself. Consisting, as is frequently the case for forecasting activity, in linear extrapolations of current trends, these projections received great attention from the mass media and political leaders, but they were greeted skeptically by many economists, including some of the most eminent of the time. Without seeking to downplay the limits and risks of the exploitation of natural resources implicit in the population explosion and exponential growth, the critics noted that the Report failed to take due account of two major stabilisers: the ability of relative prices to rebalance supply with demand and the response of technology. Notwithstanding the demonstrated power of these two mechanisms, which makes such longterm projections hazardous, the concern has not abated. The debate on “sustainable development” – development that can “meet the needs of the present without compromising the ability of future generations to meet their own needs” 4 – shows that today it is impossible to ignore the environmental balance of the planet and the reciprocal compatibility, or tradeoffs, between economic, social and ecological objectives. Climate change is no longer a scientific curiosity; it is a fundamental theme of today’s public debate. A significant step was the 2006 Stern Report, 5 which followed a series of important international agreements (chief among them the Kyoto Treaty of 1997) and thoroughgoing albeit undervalued studies by the World Bank and the OECD. Some of its assumptions were criticised, such as the discount rate it used to estimate economic costs, which was very low and thus – like The Limits to Growth – likely to neglect potential mitigating and feedback effects, such as those connected with technical progress. But two of the Stern Report’s recommendations appear to be of special importance: to tackle the challenge of climate change at a global level, with the cooperation of all concerned, advanced, emerging and developing countries alike; and to devise incentives for the invention and use of new technologies to drastically curtail emissions of carbon dioxide and other greenhouse gases. I. Morris, Why the West Rules – for Now: The Patterns of History and What they Reveal about the Future, New York, Farrar, Strauss and Giroux, 2010. D.H. Meadows, D.L. Meadows, J. Rangers and W.W. Behrens III, The Limits to Growth: A Report for the Club of Rome’s Project on the Predicament of Mankind, New York, Universe Books, 1972. United Nations, Report of the World Commission on Environment and Development: Our Common Future, New York, 1987. N. Stern, The Economics of Climate Change: The Stern Review, Cambridge, Cambridge University Press, 2007. BIS central bankers’ speeches Fifty years of great change The transformations of the past half-century may not have been either linear or painless, but the gain in well-being for most of humanity has been extraordinary. The driving force has been technological change. This is made clear in a recent article by Ayhan Kose and Ezgi Ozturk in the International Monetary Fund’s slender review, Finance & Development. 6 The epoch-making impact of information and communications technology becomes self-evident if we compare the time, cost and process of drafting and publishing an article today and fifty years ago: a computer instead of a typewriter; the immediate online availability of data and bibliographical references, rather than their laborious acquisition in print, possibly requiring visits to more than one library; worldwide transmission with a single click via e-mail and Internet, in place of print and the traditional distribution of paper copies by post. The progress generated by the exponential growth in the computing power of microchips (predicted fifty years ago by the legendary “law” of Gordon Moore 7) transpires from two simple facts. Today’s typical smartphone has 3 million times the computing power of the first minicomputer marketed successfully in 1965, at one 225th the cost. And I presume that the power is improving and cost is decreasing even as we speak. To add an example drawn from my own experience, back in the 1970s producing forecasts and economic policy analysis based on simulations from an econometric model – which at that time meant solving a hundred or so equations – could take several hours of dataprocessing time. Already by the early 1980s, when we built the Bank of Italy’s quarterly model of the Italian economy, the time needed for each simulation had fallen to just a few minutes. Today we can carry out complex stochastic simulations in just a matter of seconds. Change gathered momentum following the end of the Cold War. The introduction of the Internet in 1991 changed our way of communicating, forever, and the mobile telephone has made communication incredibly widespread and incomparably cheaper. The first commercial communications satellite was put into orbit by the United States in 1965; we currently have about 400 active satellites worldwide. Whereas in 1980 there were 5 mobile phone subscriptions per million population, there are now 90 for every 100 people. Technological advance has brought about much more efficient energy use, saving more than 25 per cent on energy for the same volume of goods and services produced, in comparison with 1991. Globalisation itself has been facilitated by the technological revolution. In transportation, the plunge in air travel prices has caused the number of passengers to soar, while rail travel has gained in speed and quality. The contribution to world growth coming from today’s emerging economies, which had been excluded from the economic integration of the twentieth century, has gone from 30 per cent in the 1965–1974 ten year average to 70 per cent over the last ten years. The world economy is six times larger now than fifty years ago and per capita output more than twice as great, even though world population too has more than doubled. At the same time, the mobility of labour has raised the number of people who live outside their native country, from under 80 million in 1970 to nearly 250 million nowadays; and the migratory flow between developing countries now exceeds that toward the West. M.A. Kose and E.O. Ozturk, “A World of Change”, Finance & Development, 51, 3 September 2014. A curious, and significant, coincidence: the authors took as epigraph to their article the verses of the same Bob Dylan song that I chose as the title for this piece. Moore – who was a cofounder of Intel – conjectured that the performance of microchips (broadly speaking, computing capacity) would double every twelve months (later re-estimated at 18-24 months); see G.E. Moore, “Cramming More Components onto Integrated Circuits”, Electronics, 38, 8, 1965. Another regular pattern in the speed of technical advance is “Wright’s law” by which the time (or the unit cost) of production (originally in the aeronautical industry) diminishes by a constant percentage every time the cumulative volume of output doubles: T.P. Wright, “Factors Affecting the Cost of Airplanes”, Journal of the Aeronautical Sciences, 3, 4, 1936. BIS central bankers’ speeches These are clearly extraordinary changes. We are living in a different economy, a different society, from those of even a quarter of a century ago: a global society, with an exceptionally rapid and extensive diffusion of ideas and knowledge, an enormous mass of information available, and nearly 300 times the global financial assets, in dollar value, compared with 1970 (while US consumer prices have risen just sixfold). In particular, the effects of combining technological innovation with the opening of markets have been astonishing. The stepped-up growth in per capita incomes and employment that has been achieved, thanks to the new “supply chains,” in many emerging countries, headed by China, is the clearest testimony. These changes, too, have not occurred in a straightforward, linear fashion, owing unquestionably but not solely to discontinuities in geopolitical equilibria. In the economic field, recurrent financial crises have struck single countries and regions, ultimately producing the extremely severe global crisis of which we still face the legacies. The world economy has gone through a recession every decade since the 1960s. The increase in welfare has not been evenly distributed among the world population. Although near a billion people still live in extreme poverty and destitution (with incomes of less than $1.90 a day, the new benchmark recently adopted by the World Bank), the objective of halving their number was attained in 2010, five years earlier than was called for by the UN Millennium Development Goals of 2000. And apart from the billion who have been lifted out of extreme poverty we should count another 2 billion added to the world population over the last twenty-five years, mostly in the emerging and developing countries, who have not entered this state. The gap in life expectancy between these countries and the Western world (where it has nevertheless continued to lengthen) has narrowed dramatically. However, while the international inequality in income distribution has diminished, the fact remains that between 1990 and 2010 domestic inequality became more severe in two thirds of the countries for which data is available.8 In the United States, while per capita output expanded by some 40 per cent between 1990 and 2007, real median household income gained less than 10 per cent. After the sharp drop in output and employment due to the financial crisis, production has now regained and surpassed its 2007 level, but median income has fallen back to the levels of over twenty years ago. It is often remarked that the wealthiest 1 per cent of the population now accounts for about 20 per cent of US national income, compared with 8 per cent fifty years ago. And the increase in the incomes of the super-rich (the top 0.1 per cent) has been sharper still, with an accentuation of the concentration of wealth. 9 “Secular stagnation” and the “second machine age” The fact that development is a non-linear process is perceptible, among other things, in the lack of substantial productivity gains in the advanced countries consequent to the spread of the new information and communications technologies. 10 In most of these countries per capita output has risen only modestly, where it has not actually contracted, as in Italy. The global financial crisis, which stemmed from the bursting of the subprime mortgage bubble in On the enormous improvement in living and health conditions practically everywhere in the world since World War II and on the uneven developments in the distribution of income and opportunities, with reference to environmental, health, and political disasters, see Angus Deaton’s profound, impassioned recent book, The Great Escape: Health, Wealth and the Origins of Inequality, Princeton, N.J., Princeton University Press, 2014. A.B. Atkinson, T. Piketty and E. Saez, “Top Incomes in the Long Run of History”, Journal of Economic Literature, 49, 1, 2011; F. Alvaredo, A.B. Atkinson, T. Piketty and E. Saez, “The Top 1 Percent in International and Historical Perspective,” Journal of Economic Perspectives, 27, 3, 2013. D. Acemoglu, D. Autor, D. Dorn, G.H. Hanson and B. Price, “Return of the Solow Paradox? IT, Productivity, and Employment in U.S. Manufacturing”, American Economic Review, 104, 5, 2014. BIS central bankers’ speeches the United States in 2007, and the euro-area sovereign debt crisis, which was triggered in early 2010 by the revelation of grave underestimates of the Greek budget deficit, have been accompanied by what has come to be known, as if in contrast to the “Great Moderation” of the previous two decades, as the “Great Recession.” 11 Even in the United States and the United Kingdom, the countries that left the acute phase of the crisis behind them most quickly, the growth rate remains lower than in the pre-crisis years. In the euro area as a whole output is still below its pre-crisis level, which it is projected to regain by the end of this year. It is now quite generally held that the “potential” growth rate too has been lowered by the reduction in investment and the very high levels of long-term unemployment and underemployment. The recession’s legacy, in other words, consists of numerous, varied problems that threaten to leave permanent, not just short-term scars on our economies. Today, there is renewed debate on the risk of hysteresis (i.e., the extent to which the short-term cycle influences the longer-term dynamics of the economy). Larry Summers has revived the “secular stagnation” hypothesis originally advanced by Alvin Hansen in the 1930s and forcefully rebutted in practice by the protracted economic expansion that followed World War II. 12 It is somewhat singular that there has been more (and earlier) discussion of this thesis in the United States than in the euro area, where the difficulties that impede a return to sustained growth are particularly evident and the deficit in employment and demand is so substantial. The new secular stagnation hypothesis refers to the increasing propensity to save (in order to pay down excessive debt) and to the reduction in investment and in aggregate demand in recent years. The decline in the relative price of capital goods induced by technological innovation, despite having resulted in a substitution of capital for labour, may also have played a role in lowering investment expenditure in nominal terms. As Summers notes, unlike new business ventures in the traditional sectors, those in the digital economy may require a reduced amount of money to start up, thus resulting in a possible reduction in the aggregate capital expenditure. In circumstances like these, maintaining the balance between saving and investment – which is essential to achieving full employment – could require a level of negative real interest rates (that is, net of inflation), that monetary policy cannot deliver. Nominal interest rates, in fact, are now close to zero and the increase in prices is minimal. The consequence is stagnant economic activity and the underutilisation of resources. Furthermore, the legacy of the financial crisis – namely the need to reduce financial leverage and decrease public and private debt – would not appear to be temporary. Against the backdrop of low inflation and reduced potential growth, the global ratio of debt to output continues to rise. 13 See, for one, C. Bean, “The Great Moderation, the Great Panic, and the Great Contraction,” Journal of the European Economic Association, 8, 2-3, 2010. For a discussion of the legacy of the financial crisis, see I. Visco, “The Aftermath of the Crisis: Regulation, Supervision and the Role of Central Banks”, CEPR Policy Insight, 68, December 2013. On the euro area sovereign debt crisis, see I. Visco, “The exit from the sovereign debt crisis: national policies, European reforms and monetary policy”, in P. Horvath, P. Mooslechner and A. Staribacher, eds., Europäische Wirtschaftspolitik der Zukunft, Festschrift zum 70. Geburtstag von Ewald Nowotny, Wien, New academic press, 2014. L.H. Summers, “U.S. Economic Prospects: Secular Stagnation, Hysteresis, and the Zero Lower Bound”, Business Economics, 49, 2, 2014; A.H. Hansen, “Economic Progress and Declining Population Growth”, American Economic Review, 29, 1939. See also C. Teulings and R. Baldwin, eds., Secular Stagnation: Facts, Causes, and Cures, VoxEU.org eBook, London, CEPR Press, 2014; and P. Pagano and M. Sbracia, “The Secular Stagnation Hypothesis: A Review of the Debate and Some Insights”, Banca d’Italia, Questioni di Economia e Finanza (Occasional Papers), 231, 2014. L. Buttiglione, P. Lane, L. Reichlin and V. Reinhart, Deleveraging, What Deleveraging? The 16th Geneva Report on the World Economy, London, CEPR Press, 2014. BIS central bankers’ speeches Apart from the short-run Keynesian effects linked to rigidity and constraints on the adjustment of relative prices, we should consider the possible medium-term repercussions that a protracted state of high unemployment and disinvestment could have on the economy’s capacity for growth. In the longer run, poor expectations for demand in connection with population ageing can make the picture even gloomier. Moreover, we are certainly aware – even if the risk is still remote – that holding interest rates very low for very long periods may result in fueling excessive financial risk-taking, imprudent lending practices and, ultimately, dangers for financial stability. 14 A second version of the stagnationist hypothesis, put forward notably by Bob Gordon, does not consider demand and investment but instead focuses on the supply side, and in particular on the rate of growth of productivity, i.e. the economy’s potential output for a given amount of available human and material resources employed in the production process. 15 The key argument here is that the great inventions that have resulted in massive productivity increases have for the most part already been introduced, so that a return to more moderate growth rates is inevitable. This thesis is at once daring and perhaps over-simplified, even though it is supported by some careful analysis of the data and of historical trends, both aggregate and sectoral. What truly characterises the new information and communications technology is its suitability for widespread use in practically every area of economic and social life. The introduction of personal computers and the Internet may have been gradual, not significantly different, in terms of the time taken, from electrification. 16 However, as Brynjolfsson and McAfee have observed, it is perfectly possible that the digital revolution is still far from having worked all its effects on productivity. Even if it is apparently gradual, the nature of technical progress in the digital age, they say, is exponential, as in the ancient (Persian) legend in which grains of rice placed on a chessboard must be doubled from one square to the next: the volume is almost negligible at first but in the second half of the board it becomes overwhelming. Not to mention other pioneering areas of research like robotics, genomics and artificial intelligence, which may have incredible applications that were once unimaginable (save for people like Jules Verne or Isaac Asimov), with an extraordinary impact on productivity and in the ultimate analysis on our well-being. This is the “second machine age.” 17 The challenge of technology Starting with the first industrial revolution, technical progress has regularly displayed the ability to engender not only widespread rises in per capita income and living standards but See also L.H. Summers, “Reflections on the ‘New Secular Stagnation Hypothesis’”, in Teulings and Baldwin, op. cit. R.J. Gordon, “Is US Economic Growth Over? Faltering Innovation Confronts the Six Headwinds”, NBER Working Paper 18315, 2012; and more recently, R.J. Gordon, “The Turtle’s Progress: Secular Stagnation Meets the Headwinds”, in Teulings and Baldwin, op. cit. For a contrary thesis, see J. Mokyr, “Secular Stagnation? Not in Your Life”, ibid. B. Jovanovic and P.L. Rousseau, “General Purpose Technologies”, in P. Aghion and S.N. Durlauf, eds., Handbook of Economic Growth, Amsterdam, Elsevier, 2005. These analyses pay little attention to the possible effects of computerization and the digital revolution on people’s cognitive capacities (beyond the impact on labour demand and the distribution of income), but other authors see them as anything but negligible. See for instance, N. Carr, “Is Google Making Us Stupid?”, The Atlantic, July-August 2008, and M. Näsi and L. Koivusilta, “Internet and Everyday Life: The Perceived Implications of Internet Use on Memory and Ability to Concentrate”, Cyberpsychology, Behavior and Social Networking, 16, 2, 2013. See also the theses of Norbert Wieser, mathematician and the inventor of cybernetics, on the severely depressing effect of automation on employment, in N. Wieser, The Human Use of Human Beings, Boston, Houghton Mifflin, 1950. BIS central bankers’ speeches also expanded and more rewarding job opportunities. The destruction of jobs in the industries affected by process and product innovation has always been accompanied by a rapid creation of new jobs in the economy as a whole. What underlies this mechanism is the ability of technical progress to trigger a virtuous sequence of productivity gains, a reduction in unit production costs, increased demand for the new goods and services, and rising national income. The digital revolution, which we experience every day in our ways of communicating and acquiring information, confirms the far-reaching benefits that the entire society obtains from technical progress. But digital technologies have a distinctive feature: the greater speed with which they tend to replace labour, even in fields in which human intervention has always appeared to be decisive. This suggests the revival of the concept of “technological unemployment” proposed by Keynes in his 1930 essay on the prospects for future generations 18 and thus indicated as one of the forces behind the decline in job opportunities and the stagnation of wages and incomes observed in a number of industries and countries. As we know, without bringing Ned Ludd or Karl Marx into it, this debate is not new. But we can recall Keynes’s own optimism and his prediction that given the tendencies of technical progress and the increase in productivity in the United Kingdom and the United States and “assuming no important wars and no important increase in population, the economic problem may be solved … within a hundred years” with a fourfold to eightfold rise in per capita income. Today we are talking about a global economy, new technologies and population ageing; we note that exceptionally violent wars and population growth have not been lacking, but even so the order of magnitude of the rise in per capita income that Keynes projected for the century does not appear to be unreasonable. However, his fear that the most severe challenge would be how to occupy our leisure time, as we would be astonishingly more wealthy but technologically unemployed, has certainly not materialised. Fifty years ago, when Dylan’s emblematic song first appeared in the United States, a small book was published in the United Kingdom that dealt with production efficiency, income distribution and corporate ownership. It was written by James Meade, an economist and Keynes’ disciple, well-known for his work in the field of international trade, which would eventually earn him the Nobel Prize in 1977. 19 More than pose the social and economic problem of what to do when automation means that “we need to work only an hour or two a day to obtain the total output of real goods and services needed to satisfy our wants,” Meade asked “What shall we do when output per man-hour of work is extremely high but practically the whole of the output goes to a few property owners, while the mass of the workers are relatively (or even absolutely) worse off than before?” 20 What can we say on this point today? To my mind, we must consider the matter on three levels. First, the crucial question is to determine whether the net loss of jobs due to technological innovation is temporary or permanent. As I recalled above, history shows that, although automation has certainly brought about the substitution of capital for labour in given economic sectors, for the economy as a whole, technical progress has been the source of new and better work opportunities. It is legitimate to ask whether things may not be different this time around. So far, in the United States and elsewhere, new technology has created a polarisation of occupations, with employment gains concentrated in low-paid service jobs and J.M. Keynes, “Economic Possibilities for our Grandchildren”, in Essays in Persuasion, London, MacMillan, 1931. J.E. Meade, Efficiency, Equality and the Ownership of Property, London, Allen & Unwin, 1964. A similar view would be put forward a couple of decades later by another Nobel Laureate, Wassily Leontief, in “Technological Advance, Economic Growth, and the Distribution of Income”, Population and Development Review, 9, 3, 1983. The implications of this terrifying prospect for income distribution – which Meade dubbed the “Brave New Capitalists’ Paradise” – are the centrepiece of a short, sharp article by Benjamin Friedman, “‘Brave New Capitalists’ Paradise’: The Jobs?”, The New York Review of Books, 7 November 2013. BIS central bankers’ speeches high-paid jobs requiring considerable educational attainment, to the expense of mid-skilled jobs. A recent, widely-cited study by two researchers at Oxford has estimated that 47 per cent of existing jobs in the United States risk being automated out of existence, possibly within a decade or two. 21 Other analysts, at the Bruegel research centre, 22 have produced estimates of over 50 per cent for the main European countries, including Italy (which so far appears to have suffered more from globalisation and the heightened competition of the emerging market economies than from technological innovation). Such estimates will certainly make a powerful impression on readers, but they must be handled with great caution, given the patent difficulty of assigning risk percentages to jobs whose content may change radically thanks to the new technology itself. In the past we have seen drastic transformations in the composition of employment: just think of the drastic drop in agricultural employment in the industrial countries since World War II. The destruction of some jobs will certainly correspond to the creation of new ones, and the net result is anything but a foregone conclusion, though of course we cannot ignore the adverse effects characteristic of a phase of transition like the present. As yet, the new information and communications technology is still complementary to managerial and intellectual jobs but substitutive of routine tasks. The new wave of technological innovation in the fields mentioned earlier (robotics, genomics, artificial intelligence) could nevertheless have a substantial impact on the labour demand relative to non-routine tasks that cannot, apparently, be standardised, at both high and low levels of skill. 23 The second question is the relationship between technological progress and the increase in income inequality so forcefully anticipated by Meade. Such a vast issue cannot be discussed in a few lines. The sensation made by Thomas Piketty’s Capital in the Twenty-First Century 24 readily demonstrates how topical it is. Here the point seems to me to be not just to decry the emergence of entertainment superstars, top executives and the great rentiers (the top 0.1 per cent of the population), who would appear to be – thanks to skill, luck, or monopoly positions – the great beneficiaries of the economic transformation of recent decades, and accordingly call for income redistribution for reasons of social equity. Rather, it is to determine the extent to which current and prospective trends in technology can alter, for the purposes of economic growth, today’s relationship between capital and labour, how great the risk is that substantial portions of the work force will be driven out of the production process, regardless of their level of education and competence. The question, therefore, is what to do to avert human, social and political consequences that are potentially very severe indeed. 25 These are clearly questions for the long term. We must be skeptical of extreme projections that would have all or almost all workers replaced by robots and the owners of capital expropriating, in the form of profit, practically all the income produced. Such predictions are afflicted by the obvious limits of linear extrapolation; they fail to consider the safeguards and C.B. Frey and M.A. Osborne, The Future of Employment: How Susceptible are Jobs to Computerisation?, Oxford Martin School, University of Oxford, September 2013. J. Bowles, The Computerisation of European Jobs, Brussels, Bruegel, July 2014. For a review of the debate see A. Sabadash, “ICT-induced Technological Progress and Employment: A Happy Marriage or a Dangerous Liaison? A Literature Review”, European Commission, Joint Research Centre, Institute for Prospective Technological Studies, Digital Economy Working Paper 07, 2013. T. Piketty, Le capital au XXIe siècle, Paris, Seuil, 2013; English translation, Capital in the Twenty-First Century, Cambridge, Mass., Harvard University Press, 2014. The issue is broached with force in Friedman, op. cit. See also L.H. Summers, “Economic Possibilities for our Children”, NBER Reporter, 4, 2013, and T.B. Atkinson, “After Piketty”, British Journal of Sociology, 65, 4, 2014. BIS central bankers’ speeches feedback that have tended to arise, in a more or less spontaneous fashion, in the course of human history. Nor, however, can we fail to observe that in the years to come, such issues as the concentration of market shares, equality of opportunity, the progressiveness of tax systems, workers’ employability, and ownership rights will inevitably be subject to political debate and decision, in a context that is difficult because, for one thing, it no longer corresponds to national borders. The third consideration, given the re-emergence of issues like technological unemployment, income and wealth concentration and the domination of capital (machines) over labour, involves the possible repercussions on aggregate demand. Those who argue that the fruits of technical progress and the relative increase in productivity will mainly benefit the relatively few owners of the new technology firms are certainly raising the question of distributive fairness. At the same time, however, if they are to be produced at all, those fruits need a sufficiently high level of effective demand. In other words, there is also a broader, macroeconomic question involving the distribution of income: in order for the goods and services that will make up tomorrow’s output to be sold, income, jobs and property will have to be widely distributed throughout the population. In other words, for the enormous increases possible on the supply side to materialise, there will have to be consumers in a position to create effective demand for the new goods and services. Supply and demand today The matters addressed to this point concern a possible future, a future that is distant but perhaps not too much so. Accordingly, in discussing them we must keep an open mind, in the awareness that it is not about tilting at the windmills of machines dominating men, or capital irremediably crushing labour. We must remember that just as today’s work is far different from yesterday’s, so tomorrow’s will differ from today’s. And the same goes for capital: “digital” capital will have very little in common with the capital of the ironmasters. Yet we cannot ignore the problems engendered by the ever-increasing computerisation of so many occupations. At a time of far-reaching transformation like the present, systems of social security for the workers who lose their jobs will have to be reinforced. In any event, the responses to the long-run slowdown in economic growth that many analysts fear cannot but be multiple, and very likely different from country to country. Benjamin Friedman, for instance, contends that at least for the United States, more and better education for an increasingly large portion of the labour force is a partial solution at best, insufficient to buffer the impact of technology on jobs and earnings. 26 On this issue, however, Ned Phelps observes that the solution is not the indefinite increase in the number of technical and scientific university graduates, 27 of whom there are already a good many in the main advanced countries, but to aim for innovation and individual dynamism, creativity and adaptability, which depend greatly on customs and which must continue to be emphasised in schools and universities, through the humanities: history, philosophy, literature. 28 Brynjolfsson, McAfee and Spence suggest, with a new spirit, a strategy that is not new but, they stress, “intellectually simple, if politically difficult”: stimulus from public investment in fields where the social return is especially high: basic research in science, technology and Friedman, op. cit. On the asymmetrical effects of the new information and communications technology on income distribution, owing to the differential complementarity between computerization and non-routine work of high and low human capital content, see C. Goldin and L.F. Katz, The Race between Education and Technology, Cambridge, Mass., Belknap Press, 2008. E. Phelps, Mass Flourishing: How Grassroots Innovation Created Jobs, Challenge, and Change, Princeton N.J., Princeton University Press, 2014. Goldin and Katz, op. cit., note that what matters most in the “race” between education and technology is cognitive skills and interpersonal relations. BIS central bankers’ speeches health; spending on education; and infrastructure, not just highways and airports but also water supply, waste disposal, electric power grids and communications networks. 29 In its October 2014 issue, the International Monetary Fund’s World Economic Outlook returned forcefully to the theme of the possible impact of infrastructural investment on short-term demand and medium-term supply. 30 In Europe, Bart van Ark, among others, maintains that if the main problem is still making good the deficit in productivity growth, then firms must rapidly catch up in adopting the new digital technologies. 31 Before asking what the future holds for us now, we must start from the recognition that there is a serious deficit in Europe, and especially in Italy, not only of growth but also of demand, hence of employment and incomes. Strong stimulus for investment, public and private, national and European, is accordingly essential. Even raising the rate of growth in productivity requires well-targeted investments in new technology, to be sure, but also in intangible infrastructures that can generate increasing returns over the medium-to-long term. If there is a lack of investment due to the high cost of capital in some countries, doubts about demand, or uncertainty over the state and continuity of “structural reforms,” it is the responsibility of the political system and economic policy – and of those in leading positions in society, in the information industry and in training and education – to act with resolution, foresight and singleness of purpose to remove these impediments. In Italy, in particular, given an economy and a society that have been practically stalled since well before the onset of the financial crisis, there is great potential for improvement, by removing constraints and rigidity, accelerating the adoption of new technology, closing the gap that separates many industries from the productivity frontier, and refurbishing infrastructures, including the most traditional ones. In the search for a new model of development, or at least a return to balanced, sustainable economic growth, we can start from Acemoglu and Robinson’s observation on how important it is to maintain a pluralist society and renew our political and economic institutions in a more inclusive direction. 32 Specifically, it is not enough to set out reasonable objectives if the conditions for attaining them are lacking. In some cases, these conditions are unlikely to present themselves. The objective of bringing manufacturing value added back up from its current 15-16 per cent of GDP to 20 per cent by 2020, as it was a decade and more ago, proposed quite emphatically in the European Commission’s strategy for the next few years 33, will run into evident historical and methodological obstacles. On the one hand it is most likely, owing notably to the spread of automation, that value added will be derived increasingly from sectors outside manufacturing. As in the case of agriculture, this does not necessarily reduce its importance for a nation’s economy or a society’s value system. But it does spotlight the risk of overstating its potential to create jobs. On the other hand, the spread of new technologies is making even the very definitions of economic sectors obsolete. E. Brynjolfsson, A. McAfee and M. Spence, “New World Order: Labor, Capital, and Ideas in the Power Law Economy”, Foreign Affairs, July-August 2014. IMF, World Economic Outlook, Chap. 3, October 2014. B. van Ark, “Productivity and Digitalization in Europe: Paving the Road to Faster Growth”, Lisbon Council Policy Brief 8, 1, The Lisbon Council, Brussels, 2014. Van Ark refers in particular to “Metcalfe’s law” (named after Robert Metcalfe, the inventor of Ethernet technology) to highlight the disproportionally large productivity effect engendered by investment in digital technology (in general, the network or interlinking effects of the technology). D. Acemoglu and J. Robinson, Why Nations Fail: The Origins of Power, Prosperity, and Poverty, New York, Crown Publishing, 2012. European Commission, A Stronger European Industry for Growth and Economic Recovery, Communication 582, 10 October 2012. BIS central bankers’ speeches Twenty years ago the Italian government announced a “three I’s” programme, in Italian “impresa, inglese, informatica”, which correspond, in English, to the “three E’s” of Enterprise, English, and computer Education. Unhappily, there is no denying how far behind we still are on all three fronts – not because the objectives were vague or implausible but because the fundamental administrative, legal, cultural and political conditions for their attainment were not present. Certainly there are financial constraints. But I do not believe that the insufficiency of investment in knowledge, in environmental and territorial protection, or in the valorisation of our nation’s incomparable artistic and cultural heritage depends solely on these constraints. There is a grave deficiency in the ability to grasp the fundamental importance of these factors as an investment in the future, including the near future. We can invent future scenarios, but we cannot foresee what our economy or our society will be like twenty or thirty years down the line. When we ask ourselves what we must do to increase demand, income, and employment, or when we point to the necessity of designing new industrial policies, the primary objective can only be to put our economic and social system in a better position to face and foster change. Unquestionably the competitive pressures of globalisation and the challenge of computerisation will require major changes in the organisation of work and the adaptation of education, training, and infrastructure. Slowness to adapt would constitute a third cause of stagnation, recently noted by Barry Eichengreen, 34 in alternative or in addition to the lack of demand, as posited by Larry Summers, and the slowdown in productivity growth prognosticated by Bob Gordon, a cause which could become the most important of all. That said, the risks of technological unemployment are aptly, if somewhat controversially, summarised in Tony Atkinson’s recent remark that “the direction of technological change should be an explicit concern of policy-makers, encouraging innovation in a form that increases the employability of workers and emphasises the human dimension of service provision”. 35 However, what we should do is not so much fear the direct impact of the new technologies and computerisation on jobs, as work to take advantage of the enormous cost reductions that will derive from them. The growth of innovative industries is now the principal engine of growth in employment and in productivity. In an influential book, Enrico Moretti has shown that every high-tech job created in a particular US metropolitan area has been accompanied by five new jobs in the traditional, low-skilled, low-education sectors. 36 Perhaps the level of generality of this result still needs to be established, but it is indicative of the powerful effects of innovation. What is certain is that people will have to work in different ways, in different jobs and different places, over a career span marked by continuous, lifelong learning and training. We must acquire the skills necessary for the twenty-first century: critical thinking, aptitude for problem-solving, creativity and acceptance of innovation, the ability to communicate effectively, and openness to cooperation and group work. This while we continue to invest in knowledge, in schools and universities, with the aim of rapidly overcoming the very serious deficit of “functional literacy and numeracy” observed in many countries (notably in Italy) by the 2013 OECD’s Programme for the International Assessment of Adult Competencies. 37 Indeed, as famously stated by Benjamin Franklin in his almanac, “An investment in knowledge pays the best interest”. This investment in knowledge must necessarily pay B. Eichengreen, “Secular Stagnation: A Review of the Issues”, in Teulings and Baldwin, op. cit. A.B. Atkinson (2014), “After Piketty?”, op. cit. E. Moretti, The New Geography of Jobs, Boston-New York, Houghton Mifflin/Harcourt, 2012. OECD, “OECD Skills Outlook 2013: First Results from the Survey of Adult Skills”, Paris, November 2013. These issues have been examined by the author in I. Visco, Investire in conoscenza, Bologna, Il Mulino, 2014. BIS central bankers’ speeches attention to scientific advances and technological progress, without losing sight of the value, the importance, the practical relevance, of humanistic traditions. 38 Italy is a case in point as to the central importance of a comprehensive design in setting out structural reforms. The clearest example is how hard it is to improve the conditions for doing business and for the creation and growth of new firms, including those providing the services required by the (new) needs of an older society. This means creating a more propitious environment by removing bureaucratic and administrative obstacles and significantly improving courts, schools and infrastructures; but it also means establishing a framework of respect for rules, countering illegality and combating crime. A good deal of our progress depends on membership in the European community. The path towards full European Union appears rocky, today, but this is not the place for another discussion of that issue. Given the present theme, I should just like to recall that almost fifty years ago now the well-known Italian economist, and later politician, Nino Andreatta saw the technology gap between America and Europe as an essential “political prod for Europe.” 39 He cited the role of the US federal government in funding scientific research and creating a market for the products of “science-based industries” in order to stress how important it was to truly assess “the negative consequences of a multiplicity of procurement policies on the part of different national governments, policies that call forth an inefficient proliferation of research efforts in individual countries and slow growth in market size.” I am convinced that today there would still be much to be gained if the EU member states could pool certain substantial portions of their budgets – infrastructural investment, research, defence and security – as part of the process that will, or should, lead from Economic and Monetary Union through Banking Union to Political Union. To conclude, the times are still changing. The times are always changing. More than seeking to anticipate change, what matters is to be ready, to seek out and create better conditions for seizing the opportunities and reducing the risks brought about by this change, to pave the way for progress that is broadly and equitably distributed. In Italy, this means to transcend once and for all the severe divide between these two areas that originated from the heated controversy involving as protagonists more than a century ago the great mathematician Federigo Enriques and the great philosopher Benedetto Croce. B. Andreatta, “Tecnologia ed economia nella controversia sul divario tra America ed Europa”, il Mulino, XVI, 2, 1968. BIS central bankers’ speeches | bank of italy | 2,015 | 11 |
Remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Monetary Policy Panel "Global Monetary System - Our Currency, Your Problem?", UBS European Conference, London, 11 November 2015. | Ignazio Visco: Global monetary system – our currency, your problem? Remarks by Mr Ignazio Visco, Governor of the Bank of Italy, at the Monetary Policy Panel “Global Monetary System – Our Currency, Your Problem?”, UBS European Conference, London, 11 November 2015. * 1. * * Since the outbreak of the global financial crisis price stability in major advanced economies has been at risk. Central banks fought this risk with both conventional and unconventional measures, countering financial instability and its macroeconomic implications. More recently the ECB adopted, and then extended, an asset purchase programme. 1 Today, I will discuss the effectiveness of this monetary measure and some concerns that have been raised regarding its possible unintended consequences. I will conclude with some thoughts on the current challenges for monetary policy in the euro area. Excessively low inflation and the risks of de-anchoring of inflation expectations 2. In the euro area downward risks for price stability increased sharply in the second half of 2014, as inflation kept falling, growth lost traction and monetary and credit dynamics remained weak. Inflation reached historically low levels also in the countries that had not been directly affected by the sovereign debt crisis. In December 2014, no country of the euro area recorded an inflation rate above 1 per cent; in 12 countries out of 18 consumer price dynamics were negative. These developments reflected not only the collapse of oil prices, but also the weakness of aggregate demand. 2 3. Inflation expectations were progressively affected by the persistent decrease in actual inflation. Indeed, in the second part of 2014 even long-term inflation expectations, which previously had hovered around the definition of price stability, begun to decline substantially. The 5-year forward, 5-years ahead inflation swap rate fell to slightly below 1.5 per cent at the beginning of this year, from around 2.2 per cent in early 2014. The Consensus Economics survey and the ECB’s survey of professional forecasters also signalled falling medium- and long-term inflation expectations in the course of 2014. 4. The risk of expectations de-anchoring from the definition of price stability was material. Since mid-2014 negative tail events affecting short-term expectations have been increasingly channelled into long-term ones, igniting both downward revisions of expectations and an increase in uncertainty. 3 These developments were particularly worrying as the formation of expectations is not a linear process: large changes can materialise in a discontinuous manner. I have recently advanced my views on the motivations for such a programme, and some related concerns, also in I. Visco, “Eurozone challenges and risks”, Central Banking, 26, 1, 2015. A. Conti, S. Neri and A. Nobili, “Why is inflation so low in the euro area?”, Banca d’Italia, Temi di discussione (Working Papers), 1019, 2015. S. Cecchetti, F. Natoli and L. Sigalotti, “Tail comovement in option-implied inflation expectations as an indicator of anchoring”, Banca d’Italia, Temi di discussione (Working Papers), 1025, 2015; F. Busetti, G. Ferrero, A. Gerali and A. Locarno, “Deflationary shocks and de-anchoring of inflation expectations”, Banca d’Italia, Questioni di economia e finanza (Occasional Papers), 252, 2014. BIS central bankers’ speeches 5. The high levels of public and private debt are also a source of concern due to the risk of activation of “debt-deflation mechanisms”. 4 Even the fact that the decrease in prices was partly associated with a favourable supply shock – the fall in oil prices − was no cause for relief. When interest rates are at the zero lower bound and credit constraints are binding the response of the economy to any given shock is modified and there is no “good” deflation: 5 in such circumstances the fall in the general price level induced by the supply shock increases the real interest rate, which in turn depresses aggregate demand and raises the real cost of servicing debt. The result could be a contraction in aggregate demand, despite the more favourable supply conditions, with further downward effects on prices. 6 The expanded asset purchase programme of the ECB 6. Against a backdrop of increased downward risks to inflation, in early 2015 the shared assessment within the Governing Council was that the measures adopted up until that time − including the programmes of purchases of covered bonds and ABS, and the targeted longer-term refinancing operations − had not resulted in the desired amount of monetary stimulus. Although they helped to significantly reduce the cost of borrowing for the private sector, the total amount of liquidity injected into the economy was less than initially expected. In late 2014 the size of the Eurosystem’s balance sheet was around €2.2 trillion, about €1 trillion (or 30 per cent) below the peak reached in June 2012. During the same period, the balance sheets of the Federal Reserve and of the Bank of England had expanded by around 60 and 10 per cent, respectively. 7. A forceful and unprecedented monetary policy response therefore became warranted: it was important to preserve the credibility of our actions and underpin expectations. At the beginning of 2015 the Governing Council decided to extend its programme of asset purchases to public sector securities. Under this new expanded asset purchase programme (APP) the Eurosystem is making monthly purchases amounting to €60 billion. As explicitly stated, the programme is scheduled to continue at least until the end of September 2016, and in any event until we will observe a sustained adjustment in the path of inflation consistent with a return to price stability. 8. The choice of this particular measure was driven by the consideration that outright asset purchases allow a more direct control of the size of the increase in our balance sheet, and hence of the monetary stimulus itself. The decision to purchase government securities reflected the need to focus on assets available in quantities sufficient to ensure an adequate degree of monetary accommodation and whose returns are able to influence the conditions of the real economy. 9. The APP is a new programme for the euro area, but it is not a revolution in monetary policy making in general. Central banks around the world have relied on large-scale asset purchase programmes to further stimulate the economy and fulfil their mandates after hitting the zero lower bound. Such measures were taken, as we all know, by the Bank of Japan, the first time in 2001, and by the Federal Reserve and the Bank of England, following the global financial crisis in 2008. It seems to me that I. Fisher, “The debt-deflation theory of great depressions”, Econometrica, 1, 4, 1933. M. Casiraghi and G. Ferrero, “Is deflation good or bad? Just mind the inflation gap”, Banca d’Italia, Questioni di economia e finanza (Occasional Papers), 268, 2015; C. Borio, M. Erdem, A. Filardo and B. Hofmann, “The costs of deflations: a historical perspective”, BIS Quarterly Review, March 2015. S. Neri and A. Notarpietro, “Inflation, debt and the zero lower bound”, Banca d’Italia, Questioni di economia e finanza (Occasional Papers), 242, 2014. BIS central bankers’ speeches these policies would have been certainly regarded as “conventional” in the 1960s and 1970s given the emphasis on changes in the composition of private sector balance sheets both in actual policy-making and in academic works on the transmission mechanism of monetary policy. 7 What is more “conventional” for a central bank than creating base money? 10. Asset purchases boost economic activity and raise inflation through several channels: they reduce yields on public sector securities, with effects on other segments of the financial market and on credit conditions for households and firms; they increase the value of assets and hence private sector spending capacity; they cause a depreciation of the currency, which impacts on imported inflation and exports; and they improve inflation expectations and public confidence. 11. Positive effects on the government bond market emerged as soon as the preparation of the programme was announced in early November 2014. Since then, though with some reversal of the initial impact during the spring, the yields on tenyear German and Italian government securities have fallen by about 25 and 80 basis points respectively. The stimulus has spread to market segments not directly affected by the asset purchases. The euro has depreciated by more than 12 per cent against the dollar and by around 8 per cent in nominal effective terms. 12. Credit conditions have also been gradually improving since the announcement of the APP: rates on new loans to firms and to households for house purchase have gone down by around 30 basis points on average in the euro area; larger reductions were generally recorded in the countries hit by the sovereign debt crisis. Positive effects can also be seen in lending volumes. After three years of contraction, the annual growth rate of credit to the non-financial private sector turned positive in April; it stood at 0.7 per cent in September. 13. The ultimate metric to gauge the effectiveness of the APP is the normalisation of the inflation rate around its medium term target. It is too early to provide an assessment, given the lags of transmission of monetary policy, but the general improvements in financial conditions, the main channel through which the programme is expected to work, indicate that so far it has been successful. Overall, the APP has helped push the intended monetary policy accommodation through the intermediation chain and reach households and firms. This is expected to support economic activity and to produce a sustained adjustment of inflation rates towards levels consistent with the definition of price stability. 8 For Italy, our analysis shows that for 2015–16 the APP can be expected to make a significant contribution to the growth of output and prices, of more than 1 percentage point in both cases. 9 The effects of the programme on euro-area output growth and inflation might be somewhat smaller, but are of approximately the same order of magnitude. What about possible unintended consequences? 14. Notwithstanding the overall positive assessment of the effects of the APP so far, remarks that stepping into this new domain may have unintended consequences on asset prices, on the return on savings and on currencies must be addressed. C. Borio and P. Dysiatat, “Unconventional monetary policy: an appraisal”, The Manchester School, 78, s1, 2010. ECB, “The transmission of the ECB’s recent non-standard monetary policy measures”, Economic Bulletin, 7, 2015. P. Cova and G. Ferrero, “The Eurosystem’s asset purchase programmes for monetary policy”, Banca d’Italia, Questioni di economia e finanza (Occasional Papers), 270, 2015. BIS central bankers’ speeches 15. First, as with any other important policy action, the risks concerning asset prices were carefully considered when evaluating the balance of benefits and possible costs of the APP. To date, there have been no signs that our purchases are provoking generalised imbalances. Financial assets and property prices in the area as a whole do not appear under speculative pressures, investors’ risk propensity is still low, and credit growth, while recovering, remains weak. Moreover, while the possibility of some undesired effects cannot be ruled out, the risks would have been far greater had we not launched the programme. Indeed, the greatest threat to the euro area’s financial stability comes from the prospect of low inflation and economic stagnation. 16. When discussing financial imbalances I believe that it is important to bear in mind the distinction between what monetary policy can and should do, and what is, instead, the domain of macro-prudential policy. 10 In the euro area, monetary policy has the primary objective of maintaining price stability over the medium-term. Macro-prudential measures should instead be used to limit the accumulation of systemic risks and to smooth the financial cycle in particular sectors or jurisdictions. Should any threat to financial stability materialise, specific macro-prudential measures can be implemented by national authorities to deal with local risks, as has recently been done in a number of countries, without the need to alter the monetary stance. 17. Furthermore, when assessing the risks related to the APP, we should not forget that the increase in risk-taking associated with portfolio rebalancing is one of the channels of transmission of the programme. Obviously, indicators of overheating should always be monitored and particular attention should be paid to credit developments in order to timely identify any possible build-up of broad-based imbalances. 18. A second worry concerning the consequences of the asset purchase programme is that, by reducing interest rates, it is “expropriating the savers”. In my view this claim is based on a very partial understanding of the role of monetary policy and, more in general, of the secular factors that are currently affecting the global economy. 19. In order to assess this concern, it is important to understand the causes of low interest rates. Their current level in the euro area, as well as in most other advanced countries, is not a bizarre choice of the central banks; rather, it reflects the degree of slack in the economy, low inflation and the gradual process of recovery from one of the deepest crises over the past hundred years. An insufficiently accommodative monetary stance in this environment would only give a false perception of higher returns on savings since it is only in the relatively short term that monetary policy can influence real returns. A longer horizon is relevant, however, for the vast majority of savers. A more restrictive monetary policy in times of economic weakness and low inflation would even be harmful to savers as it would exert a negative impact on the economy and, in turn, on its capacity to achieve higher real returns. 11 20. That said, the potential repercussions for specific sectors of the financial system should certainly not be ignored. Concerning banks, while in the short-term low interest rates might exert a negative impact on profitability, this effect will be progressively more than compensated by the medium-term positive impact of the monetary stimulus. In some countries, the low interest rates could cause problems for pension funds and insurance companies, whose liabilities allow for defined benefits or guaranteed minimum returns. These companies should limit risks by seeking a better match between the yields and duration of balance sheet assets and I. Visco, “The challenges for central banks”, Central Banking, 25, 1, 2014. U. Bindseil, C. Domnick and J. Zeuner, “Critique of accommodating central bank policies and the ‘expropriation of the saver’: A review”, ECB, Occasional Paper Series, 161, 2015. BIS central bankers’ speeches liabilities, improving operating results through portfolio diversification, increasing technical reserves and, where necessary, adjusting their obligations to policy holders to the new market scenario. 21. A third criticism of asset purchases is that they might be used as an instrument to obtain competitive advantages over other countries and, in turn, give rise to “currency wars”, with obvious detrimental effects for the global economy. These worries are misplaced. The measures currently implemented in the euro area, including the APP, are intended to bring inflation back in line with the definition of price stability. They exert their impact on the economy through different channels: the foreign exchange rate is only one of them; it is not by any means a target of monetary policy; it reflects differences in the cyclical positions of countries. Recent developments and the challenges for monetary policy 22. The persistent slowdown of emerging economies − which has also recently reflected the difficult path of adjustment in China from high levels of investment and debt – has put further downward pressure on commodity prices and increased downward risks for the world economy. Economic activity has continued to expand in the main advanced countries although at a somewhat slower pace. 23. While in the euro area recovery proceeds, downside risks have increased. More importantly, in an environment characterised by a prolonged period of low inflation and with additional downward pressures already in the pipeline − as signalled by the subdued dynamics of producer price inflation − the risks of a further decline in inflation expectations and of their de-anchoring from the definition of price stability remain non-negligible. 24. At our last meeting in Malta we stressed that the strength and persistence of the factors that are currently slowing the return of inflation to levels below, but close to, 2 per cent in the medium term require attention and thorough analysis. In this context, the ECB Governing Council will re-examine the degree of monetary policy accommodation at the December monetary policy meeting, when the new Eurosystem staff macroeconomic projections will be available. 25. The appropriate degree of monetary accommodation has to be maintained to fulfil our mandate. This may imply, as it has been stated, a change in the size, composition and duration of the APP. The possibility to once again lower the interest rate on the deposit facility will also be assessed. So far the introduction of negative interest rates in the area has been smooth; other countries seem not to have experienced difficulties in lowering rates further into negative territory. 26. Let me conclude with the obvious remark that monetary policy cannot guarantee strong and lasting growth on its own. Lacking a common fiscal capacity, demand in the euro area must draw support from a reasonable use of existing flexibility within the limits of European fiscal rules. At the same time the creation of new income, new demand, and new jobs must be supported by measures and reforms designed, as of now, to raise productivity and enhance growth potential. These reforms should take into account the structural challenges that characterise our “new world”, including demographic developments, the new wave of technological progress, climate change. A marked expansion in activities that require expertise and new skills is ahead, but at the same time it is possible that the scope for employment in the sectors most susceptible to automation and to the growth of the digital economy will shrink, even considerably. Monetary policy cannot be a substitute for the needed reforms, it can only provide favourable conditions to speed the process up and absorb its short-term costs. BIS central bankers’ speeches | bank of italy | 2,015 | 11 |
Dinner speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the 50th Anniversary Conference of the Istituto Affari Internazionali, Rome, 13 November 2015. | Ignazio Visco: European Union – progress or regress? Dinner speech by Mr Ignazio Visco, Governor of the Bank of Italy, at the 50th Anniversary Conference of the Istituto Affari Internazionali, Rome, 13 November 2015. * * * I first wish to thank the Istituto Affari Internazionali for inviting me this evening. And I congratulate the Institute founded by Altiero Spinelli for its activity, research and contributions over the last fifty years. Best wishes for a future as rich and productive. Assessing the recent and prospective evolution of the European Union is an issue far too vast to be addressed in detail in a short speech. My remarks will therefore focus on what I see as key elements concerning what was neglected before the crisis, the changes introduced over the recent difficult years, what further advancement is needed, and, to be somewhat provocative, some risks of a regress instead. On the way to the crisis Today the discussion on reforming the governance of the EU and the euro area centres on the need to complete the EMU and make it stronger, on how to get to “a deep and genuine economic and monetary union”. 1 The need to move towards political union is widely and hotly debated. But for a long period this issue was underrated and neglected. I recall the discussions that took place in the late 1990s in OECD Committees, and the analysis put forward in monographs and surveys. The 1999 OECD report on EMU, for instance, noted that “long lasting monetary unions among major sovereign nations have never been observed before, without strong political integration”, but then focused on different issues. Its discussion delved into the costs and benefits of a monetary union, the role of the Stability and Growth Pact, institutions and processes for macroeconomic policy co-ordination, exchange rate targets, labour market and wage flexibility, labour mobility, and product market reforms. 2 Interestingly, the same report underscored the potential advantages of a single monetary policy – not a single fiscal policy – in managing asymmetric shocks. It argued that such shocks “are more easily absorbed in a monetary union where monetary policy should adopt the stance most appropriate for the area as a whole than under the previous arrangements, which were at times shaped by domestic German policy considerations”. Also in subsequent analyses, the words “state” or “political” were more often missing than not. The attention was instead on such issues as fiscal consolidation, ageing populations, financial fragmentation, incomplete capital market integration, monetary policy communication, decentralized banking supervision, under-utilisation of human capital, insufficient structural reforms, all of which were diligently analysed with foreseeing discussions. Yet awareness of the need for what today is termed a common “fiscal capacity” had been present well before the signing of the Maastricht Treaty. A report on fiscal union (the MacDougall Report) was published already in 1977 on behalf of the European Commission, and a mention concerning the economic desirability of a transfer of fiscal sovereignty to the European level is present even in the 1970 Werner Report. Later on, the technical papers European Commission, A Blueprint for a Deep and Genuine Economic and Monetary Union – Launching a European Debate, COM(2012) 777 final/2, Bruxelles, 2012. OECD, EMU Facts, Challenges and Policies, Paris, 1999. BIS central bankers’ speeches accompanying the 1989 Delors Report and subsequent work by the Commission discussed the topic in depth. 3 The discussion was well alive also in academia. Economists have discussed the costs and benefits of membership of a monetary union since the seminal contribution on optimal currency areas by Robert Mundell in 1961. 4 Peter Kenen was the first to point out in 1969 that a shared fiscal policy could reduce the costs of being a member of a monetary union. He argued that the operation of area-wide automatic fiscal stabilizers would allow re-establishing equilibrium while limiting the necessary reduction (increase) in domestic prices and wages in countries affected by an adverse (positive) asymmetric demand shock. 5 The introduction of the euro was a fundamental step in European history, a political event that certified the progress made on the road to integration, a profound economic and social change. It was only a step, however, and not the end of the road. Tommaso PadoaSchioppa, who contributed so much to the achievement of monetary union, was well aware of this. On May 3, 1998, when Europe was completing the last steps before the adoption of the single currency, he wrote in a column for “Corriere della Sera”: “The Union has full competence for microeconomic policy (…), but its capability for macroeconomic policy is, with the exception of the monetary field, embryonic and unbalanced: it can avoid harm (excessive deficits) but it cannot do good (a proper fiscal policy). (…) It is thus right not only to applaud yesterday’s step but also to underline its unfinished nature, the risks and the rashness.” 6 At the beginning of the euro, Tommaso spoke clearly of the perils and weaknesses of a “currency without a State”. With the global financial crisis and more specifically with the sovereign debt crisis the importance of the unification process has become crystal clear, but, in the words of Padoa-Schioppa, “there is more bitterness than satisfaction in witnessing a prophecy come true. […] It is clear that we needed more of a European State, not less of a European currency: without the euro, Europe would now be living a catastrophe. One reason for the lack of credibility of national politics is that it keeps on giving people the illusion that national powers are capable of tackling issues (energy, climate, finance, security, migration, primary goods) which are not national, but continental and global.” 7 In the absence of political union, the economic governance of the area was based on a fragile alliance between market forces and rules of conduct. Market forces were to ensure the economic convergence of the member countries and the definition and implementation of the necessary structural reforms at national level. Rules of conduct were expected to guarantee prudent budgetary policies. But economic convergence was slow and difficult; in some cases the gaps actually widened. In many economies the delays and obstacles to adjusting to the large-scale global changes weakened competitiveness and the ability to grow. Mitigated by the improvement in funding conditions after the introduction of the euro, market pressures alone were not sufficient to drive the necessary reform efforts. Moreover, the rules for the public finances defined in the European sphere were seldom respected and sovereign risks were basically not priced by the markets: until the outbreak of the crisis the spreads between government bond yields within the euro area were close to zero. European Commission, “Stable Money, Sound Finances. Community Public Finances in the perspective of the EMU”, European Economy, 53, 1993. European Commission, The Economics of Community Public Finance, European Economy – Report and Studies, 5, 1993. R.A. Mundell, “A Theory of Optimum Currency Areas”, American Economic Review, 51, 1961, pp. 657–65. P.B. Kenen, “The Theory of Optimum Currency Areas: An Eclectic View”, in R.A. Mundell and A.K. Swoboda (eds.), Monetary Problems in the International Economy, University of Chicago Press, Chicago, 1969. T. Padoa-Schioppa, “Il passo più lungo”, Corriere della Sera, May 3, 1998. T. Padoa-Schioppa, Interview with la Repubblica, August 6, 2008. BIS central bankers’ speeches Perhaps the convergence process had been displaced, firstly, by the acceleration of the enlargement of the EU and increased participation in the Eurosystem and, secondly, by a clear (though according to some, irrelevant) predominance of intergovernmental agreements over the so-called community method. The response to the crisis In this framework, after the global financial crisis and the very severe global recession in 2008–09, the full revelation of the conditions of Greek public finances produced tensions, which then spread to the economically weaker euro-area countries, characterized by excessive public or private debt, a foreign trade deficit, poor competitiveness, and low economic growth. Tensions grew with the bursting of the property bubble and the consequent disruption of banking in Ireland. With the announcement of the involvement of private investors in restructuring Greek debt in the summer of 2011, financial markets suddenly became aware of the implications of the ban on interventions to rescue member states under the Treaty on European Union. There followed a very serious crisis of confidence in the ability of the single currency to survive, with negative consequences for the real economies of individual countries and for the area as a whole. The list of potential causes of the crisis is rather crowded. Fiscal imbalances, labour market rigidities and competitiveness deficits, insufficient innovation and productivity growth, excessive bank lending from core to periphery countries, all these have been good cause of lags, disturbances and vulnerabilities. But I believe that the sovereign debt crisis should be interpreted first and foremost as a major lack of trust in the future of the EMU, the euro and possibly the EU. The severity of the sovereign debt crisis, which at some point threatened the very existence of the single currency, owes in part to the incompleteness of the EMU project, which dramatically exposed the reversibility of even the major progress towards European financial integration made with the introduction of the euro. The rise in yield spreads between government bonds in the euro area was determined by two factors, one national and one European, linked respectively to the weaknesses of some countries’ economies and public finances (sustainability risk), and to the incompleteness of European construction and the attendant fears of a break-up of the monetary union (redenomination risk). Europe’s response to the sovereign debt crisis has consequently been two-pronged: on the one hand, individual countries have pledged to adopt prudent budgetary policies and structural reforms to support competiveness; on the other, a far-reaching reform of EU economic governance has been undertaken. The definition and implementation of this response was not smooth, let alone optimal. But the constraints were significant ─ first and foremost, the lack of trust among member states, partly justified by the episodes which ignited the crisis (fiscal misreporting and failures in financial supervision). Moreover, there was a lot of ground to be covered in a very short term. Europe had no tools with which to manage a sovereign crisis and the legal basis for providing financial support to countries in distress had to be defined. International treaties needed to be drafted and ratified, also to strengthen peer oversight on national fiscal policies and structural reforms. Further integration of financial markets was necessary to increase the resilience of the area to asymmetric shocks: the banking union and the on-going project of the capital market union are both far reaching reforms, affecting in depth the institutional fabric of member countries. The ECB Governing Council, by providing a series of conventional and unconventional monetary policy measures to fulfil its price stability mandate, ensured accommodative financial conditions that mitigated the fall in aggregate demand and helped to “buy” the considerable time needed to implement this strategy, while countering market uncertainties that could undermine its implementation. The European strategy to respond to the crisis has brought overall a stabilization of financial conditions and an easing of tensions in sovereign debt markets, even if we are still in deep and at times unknown waters. But, obviously, BIS central bankers’ speeches monetary policy cannot guarantee strong and lasting growth on its own, it cannot be a substitute for the needed reforms, it can only provide favourable conditions to speed the process up and absorb its short-term costs. A successful effort requires, once again, action at both the national and the European level. Lacking a common fiscal capacity, demand in the euro area must draw support from a more convinced use of the available fiscal space. In particular, this implies a substantial, and symmetric, respect of the requirements of both the Excessive Deficit Procedure and the Macroeconomic Imbalance Procedure. In the case of national budgets, the existing flexibility should be reasonably used within the limits of European fiscal rules. At the same time the creation of new income, new demand, and new jobs must be supported by measures and reforms designed, as of now, to raise productivity and enhance growth potential. These reforms should take into account the structural challenges that characterise our “new world”, including demographic developments, the new wave of technological progress, climate change. A marked expansion in activities that require expertise and new skills is ahead, but at the same time it is possible that the scope for employment in the sectors most susceptible to automation and to the growth of the digital economy will shrink, even considerably. The way forward The Five Presidents’ Report published in June 2015 8 sets out a roadmap for completing the EMU and, specifically, to increase its resilience to local shocks. It calls for contemporaneous progresses along four dimensions: ensuring that each economy has the structural features to prosper within the Monetary union (economic union), limiting risks to financial stability and increasing risk-sharing within the private sector (financial union), ensuring both fiscal sustainability and fiscal stabilization (fiscal union), and providing democratic foundations for all the above (political union). The Report makes proposals to be adopted in two stages and a recent Communication by the European Commission takes forward key elements of the first stage. On economic governance, such elements include the introduction of national “Competitiveness Boards” (mirroring the creation of national Fiscal Councils introduced by the six-pack for fiscal surveillance) and of an advisory “European Fiscal Board” (providing an independent evaluation of the implementation of the EU fiscal framework). In addition, steps towards financial union are also considered (notably through a European Deposit Insurance Scheme), as well as a more unified representation of the euro area in international organizations. For the long term, the Report calls for the creation of a fiscal stabilization function for the euro-area, complementing national instruments to cushion severe negative shocks. Participation in this shock-absorption mechanism would be conditional on compliance with common standards in economic convergence. Unsurprisingly, the Report is far from being uncontroversial, most notably in the fiscal area. According to some, the weaknesses are such that the Report risks to be another “missed opportunity”. 9 One can doubt the benefits of introducing further layers of “technocratic” control in an already complex framework, often criticized for lack of democratic accountability. In the medium term, and at least until the creation of a common fiscal stabilization function, the shock absorption capacity of euro-area countries remains dangerously limited (especially for those countries with limited fiscal space). In the longer term, since access to the common fiscal capacity would be conditional on significant and sustained economic convergence, Completing Europe’s Economic and Monetary Union, prepared by Jean-Claude Juncker, in close cooperation with Donald Tusk, Jeroen Dijsselbloem, Mario Draghi, and Martin Shultz. F. Saccomanni, “The Report of the Five Presidents: A Missed Opportunity”, Documenti IAI, 15|14, July 2015. BIS central bankers’ speeches there is a risk of introducing a new source of tensions among different Member States within the euro area. Regardless of its individual proposals, in my view the key questions to ask about the Report are two: Are we going in the right direction? And, are these efforts sufficient? I believe that, however arduous it might prove, it is worth proceeding along the roadmap set out in the Report. But it might not be sufficient. I believe that more progress on the side of the political union should not come sequentially, at the very end of the process, but important elements should be considered right away. In other terms, more action at the economic and financial level needs to be accompanied by parallel action also at the institutional and intrinsically political level: for example, on the legal side (from company and bankruptcy laws, to more basic rights and principles); on solidarity and welfare; on defence and security; on the timing of elections, and so on. There is also a case for reversing the de facto predominance of the intergovernmental approach on the so-called community method, even if we must be aware of the risks of this being dominated by an excessively administrative and bureaucratic policymaking. I often joke that, for a sense of shared purposes to be built-up in the euro area and to fully remove uncertainty in the eyes of interested external partners and observers, perhaps it would have been better to have a “single army” before adopting a “single currency”…. Jokes apart, and aware that issues such as this have been very much debated over the last sixty years or so, I believe that those taken in the last few years on monetary policy and banking supervision are critical steps ahead towards a stronger union. Financial fragmentation along national lines, which came to represent a hallmark of the euro area crisis, has been reversed by the European response to the crisis; financial integration is now back to a level comparable to pre-sovereign debt crisis levels, although some fragmentation still remains. However, the recent opposition to a common European Deposit Insurance Scheme is unwelcome news if not outright regress. Some claim that for European integration to proceed more collective responsibility needs to be necessarily accompanied by a parallel transfer of sovereignty. One may reply that this transfer of sovereignty has already taken place for monetary policy and banking supervision, without the corresponding introduction of common macroeconomic stabilization mechanisms or common deposit insurance. What is certain, most of the actions needed to strengthen EMU calls for trust. A confrontational approach would be detrimental. Much can be done at the level of the European Institutions – Parliament, Council, Commission – to make them better instruments of a genuine Union, rather than a collection of states. Each country must continue to build on the progress made so far, before or during the crisis, in macroeconomic and structural adjustment. All must show some understanding for their peers and play their part in renewing a shared sense of purpose and trust. We have to realize that Europe’s strength lies in the fact that we are united. BIS central bankers’ speeches | bank of italy | 2,015 | 11 |
Keynote address by Mr Ignazio Visco, Governor of the Bank of Italy, at OECD-Euromoney Conference on Long-Term Investment Financing, Paris, 19 November 2015. | Ignazio Visco: Investment financing in the European Union Keynote address by Mr Ignazio Visco, Governor of the Bank of Italy, at OECD-Euromoney Conference on Long-Term Investment Financing, Paris, 19 November 2015. * * * I first wish to thank the OECD and Euromoney for inviting me here today. Following the outbreak of the global financial crisis, Europe experienced a large fall in investment, which continued throughout the sovereign debt crisis. The fall was unusual in terms of severity and duration. Set equal to 100 its pre-crisis peak in 2007, in 2014 real gross fixed capital formation was still lower than 85 in the euro area while it had almost fully recovered in the United States and the whole OECD economies. Moreover, investment trends in Europe were very heterogeneous: compared to a level of 100 in 2007, last year real gross fixed capital formation was equal to 105 in Germany, 97 in the United Kingdom, 94 in France and lower than 70 in Italy and Spain. There is no need to add much on the short- to medium-term outlook, except to underline that the growth recovery in advanced countries, and especially in the euro area, is still fragile, as it faces non-negligible headwinds from the slowdown in emerging economies. The dramatic recent developments, which culminated in the so difficult to comprehend, and cope with, terrorist attacks here in Paris, certainly add their negative weight on confidence and raise the level of uncertainty. This may make the recovery in capital accumulation more difficult to sustain. It is against the backdrop of such an exceptional decline in capital formation that we have to analyse investment financing in Europe. I will offer some remarks on three issues: the need to diversify the European economy’s sources of financing and overcome financial markets fragmentation; the challenges of the Capital Markets Union (CMU); and some key issues that come up in financing infrastructures. 1. Diversifying financing sources and improving financial market integration The European Commission proposal unveiled last February to establish a Capital Markets Union by 2019 has among its primary objectives the broadening of non-bank sources of financing and lowering barriers to cross-border investment. The need to achieve a more diversified financial system is especially due to the bank-centric character of European financial systems. The European economy is as big as the US one, but Europe’s equity markets are less than half the size, its non-bank debt markets less than a third. According to the Commission’s estimates, European SMEs receive five times less funding from capital markets than their US peers do. Identifying the effect of financial factors on corporate decisions has always been a daunting task. Nonetheless, econometric estimates by the Bank of Italy show that the collapse of corporate investment in Italy since 2007 was aggravated at the height of the crisis by financial factors, namely tightening in banks’ lending standards and the surge in the user cost of capital. These factors were obviously connected with the heightened uncertainty determined by the global financial crisis and the sovereign debt crisis in the euro area, which also led to a very weak credit demand. It is fair to say that the dominance of bank lending is one of the causes underlying the slower recovery of the euro-area economy when compared with more diversified financial systems such as in the US or the UK. There is evidence that, during recessions, market-based financial systems are more resilient than bank-centric systems, especially when the fall in economic activity goes hand in hand with a financial crisis. Moreover, as economies develop, capital markets become comparatively more important because they improve investors’ BIS central bankers’ speeches portfolio choices and risk management techniques and broaden the set of financing tools available to borrowers. As the most acute phase of the financial crisis and its aftermath is over, a number of factors weigh on bank lending. On the one hand, the major overhaul of financial regulation is reflected in stricter banks’ capital, liquidity and leverage ratios. Moreover, the low-return environment tightens banks’ margins. On the other hand, the demand for credit is weakened by non-financial corporations’ drive to deleverage and the challenging economic environment. The regulatory push and the other forces, while combining to build a safer financial sector, are leading banks to adjust their business models, with longer-term effects on their lending activity. The CMU aims to promote a financial system that is not only more diversified but also more integrated across countries. Financial market integration in Europe is incomplete and fragile. In 2011–12, at the peak of the crisis, fragmentation of the euro area financial markets along national lines made an abrupt return, hampering the regular and uniform transmission of monetary policy across the area and severely limiting the ability of financial markets and institutions to smooth shocks across countries. Given the incompleteness of the European institutional architecture, the sovereign debt crisis called into question even the very survival of the single currency. While sovereign credit risk premia in the euro area have, over the last three years, been substantially retraced, European capital markets as a whole remain relatively underdeveloped and fragmented. The importance of pursuing better integration of European financial markets has been emphasised in the report on Financing business investment recently delivered to the French Prime Minister by a task force led by François Villeroy De Galhau. Out of the 10 proposed policy recommendations, only 3 are targeted at the French context, while the other 7 call for European and international action. As a result of the political push towards more diversified and integrated national financial systems, going forward, capital markets and non-bank financial institutions will have to take on a larger role in corporate financing in Europe and remaining obstacles to cross-border investments will have to be overcome. The Banking Union and the Capital Markets Union should complement each other. I have often underscored the fact that the benefits expected from the CMU can be magnified by exploiting the complementarities between bank financing and market financing. To begin with, banks can reinforce their central role in the financial system if they prove able to accompany the shift of part of the intermediation process from them to the markets by expanding their activity in the field of services and assisting firms in direct capital raising. Secondly, high quality securitisation, one of the CMU’s short-term priorities, can effectively blend the banks’ comparative advantage in screening and monitoring borrowers with market funding, allowing banks to free up regulatory capital, increase their lending and manage credit risks more efficiently. In the same vein, broadening funding sources for firms provides benefits also to banks. Better access to non-bank financing, notably equity capital, improves firms’ financial structure, supports innovation and makes them more creditworthy, thus safeguarding banks’ balance sheets and avoiding vicious firm-bank loops. This is not to deny that the CMU can put pressure on banks. By enlarging the pool of financial instruments available to households, the CMU creates incentives to allocate savings out of bank deposits; it may also contribute to narrow banks’ margins on loans to households and firms, to the extent that borrowers gain access to a larger set of alternative financing solutions. BIS central bankers’ speeches 2. The challenges of the Capital Markets Union The CMU is ambitious and prioritisation is the key to advancing it effectively. The Action Plan on Building a CMU, presented by the Commission on September 30, sets out both the actions needed to build the CMU and a calendar for their implementation. Short-term actions range from (i) a legislative proposal to develop simple and transparent securitisation, possibly subject to favourable prudential treatment, through (ii) a revision of the capital requirements on investments in infrastructure for insurance companies, to (iii) the simplification of the Prospectus Directive (so as to facilitate listing for firms, especially SMEs). Consultations have been launched on cross-border investments in venture capital as well as on covered bonds, retail financial services and the impact of financial regulatory reforms. These are all steps that go in the right direction, and we look forward to having them implemented in a timely manner. But the challenges are tougher over the longer term. Let me highlight what I think are the key policy directions and then I will move to the important topic of investment in infrastructures. First, it is essential that more risk capital flows to firms that want to innovate and grow in size. Equity financing is best suited for higher risk and innovative projects, that display strong information asymmetries and mostly translate into intangible assets; the low availability or lack of tangible assets to offer as collateral for debt finance is a serious issue, especially for start-up firms. Equity can be raised through individual investors, venture capital or private equity funds, or, when a company matures, listing on a stock exchange. Private equity or venture capital financiers also provide managerial expertise and deeper knowledge of innovative sectors. Going public makes it easier to raise additional equity, reduces the cost of capital, enhances the discipline of firms’ management and allows shareholders to sell their shares more easily. In the European Union, while the overall share of (listed and unlisted) equity on firms’ liabilities is broadly comparable to that in the United States, only one third of this equity is accounted for by listed shares compared with slightly more than half in the US. As for venture capital, it represents a negligible share of firms’ external finance, much lower than in the United States. Firms’ capital bases can be strengthened by pursuing a more neutral tax treatment of equity compared to debt, through, for example, an allowance for equity in corporate income tax. Such allowances could be strengthened for firms that list their shares on stock exchanges. Equity financing can also be supported by tax incentives, targeted for instance to innovative firms or venture capital investors. These are examples of measures that have been introduced in Italy in recent years. Second, informational barriers about corporate borrowers, in particular SMEs, should be overcome. Financial claims on unlisted firms are typically risky and illiquid. They call for specific professional skills and information. Many investors thus need services and infrastructures to acquire and analyse the information necessary for risk assessment. The European Commission wants to facilitate the exchange of best practices in the (private or public) provisioning of advisory services to businesses looking to develop and grow. It is also planning to link up national information services on credit risk, such as central credit registers, in order to build pan-European information systems. Data standardisation will be facilitated by the ECB AnaCredit database on corporate loans, which is currently being developed. Third, non-bank debt finance has to become a structural component of corporate financing alongside bank lending and equity. In a number of countries, including Italy, there have been national initiatives to promote the investment in, or the direct supply of loans to, mid-sized firms by long-term institutional investors and investment funds. Such initiatives should be coordinated. The private placement market is also gaining ground in some countries. This is a form of financing that allows firms to directly place their bonds with institutional investors and other qualified market participants at a lower cost than that of issuing securities to the BIS central bankers’ speeches public. Its further development requires process standardisation and a greater availability of information on credit risk to institutional investors. Fourth, national laws on insolvency, tax and securities should become more homogeneous. In particular, debt finance would greatly benefit from a greater convergence of insolvency and restructuring proceedings across European countries. Potential discriminatory taxation rules should also be tackled. The harmonisation of national laws will inevitably be a gradual process. As also recently suggested in the Villeroy de Galhau Report on investment financing, we should not rule out any possible solution a priori, from the definition of common principles to the devising of a European solution (such as a European insolvency procedure). It will also be preferable to follow a modular approach, starting with the easiest reforms and then subsequently gauging where there is room to tackle more ambitious challenges. Other very important policy actions included in the CMU proposal are the removal of market infrastructure obstacles to cross-border investment, the promotion of a European market for personal pensions plans, and the enhancement of the supervisory practices and macroprudential framework for financial markets. 3. Key issues that come up in financing infrastructures The CMU is also intended to be a key support and complement to the EC Investment Plan for Europe. There is broad consensus that raising investment, notably in infrastructure, is a key priority to strengthen the recovery. At the same time, along with lending to SMEs, the financing of infrastructure displays distinct challenges that deserve outmost attention, notably the role and needs of institutional investors and the regulatory framework for long-term investment. Infrastructure financing takes centre stage within the EC Investment Plan for Europe, which marks a first attempt to organise coordinated fiscal action to revamp investment in Europe as a whole. The overall size of the resources that will be raised by the Plan through its European Fund for Strategic Investments (EFSI) is a relevant but perhaps over-emphasised issue. What matters more is the ability of the EFSI to become a tool through which public and private resources can be channelled towards sectors that are important for productivity growth and job creation, such as infrastructures and SMEs. The main challenge for the Plan comes from the demand side, i.e. the availability of suitable projects. Designing the construction and financing of a new infrastructure is a complex operation that takes time. In order to build a rich pipeline of bankable projects, the Plan introduces two specific advisory tools at an EU level, a knowledge hub and a project portal. These two initiatives are designed to facilitate the sharing of information and best practices and to enhance the matching of individual projects to financing options. They will be available for all investment projects, not only those that intend to seek funding from the EFSI. Research carried out at the Bank of Italy on the Italian experience in Public-Private Partnerships (PPPs) since the mid-nineties highlights the difficulties that emerge in structuring these operations, due above all to pitfalls in the regulatory framework and limited availability of data. Improvements would arise from a systematic recourse to ex-ante analyses of risks, an appropriate standardisation of contracts, an in-depth monitoring of single operations and an improvement in the efficiency of public administration. It must be underlined that the preparation of contracts greatly benefits from the recourse to soft law instruments such as guidelines, standard documents and best practices, which testifies to the importance of several reports on PPPs that have been recently produced by the OECD, the World Bank and other international organisations and discussed at G20 level. But there are challenges also regarding the supply of funding, i.e. the availability of financial resources for investments in infrastructures. Pension funds and insurance companies are types of “patient” investors that fit optimally for investing in infrastructure and long-term BIS central bankers’ speeches projects However, as the OECD and the EC have well documented, their exposure to infrastructures is limited. In Europe, two important steps ahead have been recently taken. The European Long Term Investment Funds are dedicated cross-border fund vehicles that can be used by both institutional and individual investors to gain exposure to long-term projects. The EC’s Communication of end-September makes another step forward by proposing measures to create infrastructure investments as a dedicated asset class that can thus benefit from more favourable regulatory capital requirements. Another thorny issue with infrastructure financing is the lack of data. Recent OECD analyses, which also draw on studies conducted by national authorities including the Bank of Italy, suggest that the scant availability of comparable and sufficiently detailed data on infrastructures and related financing is a problem common to all G20 countries and applies to both the macro as well as to the micro level (i.e., firm or project data). We also need more information on the risk/return properties of financial claims on infrastructures. The OECD research on infrastructure as an asset class is particularly important, as it would help shed light on the riskiness of this type of investment compared with traditional asset classes and its hedging properties, especially in relation to the needs of long-term institutional investors such as pension funds and life insurers. Concluding remarks The Banking Union and the Capital Markets Union share a common goal: fostering investment and, ultimately, growth. Since its peak in 2007, gross fixed capital formation in the EU has dropped by about 10 percent in real terms. The need to support investment – national and European, private and public – in order to strengthen the recovery in the euro area, is paramount. Finance for growth has been one of the priorities of the Italian Presidency of the Council of the European Union in 2014. In many analyses the need to support investment stands out singularly as a shared priority. The ongoing push to diversify the sources of financing for investment contributes to the building of a stronger and safer financial system. However, banks will generally remain the primary source of credit for non-financial companies, notably SMEs. It is thus paramount to continue all efforts in strengthening the European banking sector. Completing the Banking Union is a priority. The Single Supervisory Mechanism (SSM) must be implemented across countries in a consistent way. The Single Resolution Mechanism (SRM) will be fully in place as of January 2016. Further progress is now proceeding or being discussed in three directions: ensuring a level playing field by addressing options and national discretions allowed for by the CRD/CRR; setting up a common public backstop to the new Single Resolution Fund; and establishing a common European Deposit Insurance Scheme. We have to move in these directions with the necessary care in order to avoid “unintended consequences” but at the same time without waiting for another financial crisis to occur. The free movement of capital is a long-standing objective of the European Union, which dates back to the Treaty of Rome. The single currency, the Banking Union, and the need to relaunch investments and potential output make it as important as ever. A stable, efficient and well-diversified financial system is also the result of effective structural policies. Both investment and investment financing flourish in sound economic environments. The rule of law, a low level of taxation on productive factors, competitive markets, efficient public administration and effective financial supervision, these are the basic ingredients of a system that is able to foster entrepreneurship and innovation, allocate resources to the most productive sectors and create good jobs. BIS central bankers’ speeches | bank of italy | 2,015 | 11 |
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